Multibillion Spanish bailout inevitable

A Spanish bailout is looking likely, writes Susana Vera, despite the government and the EU dismissing talks of a rescue package

ECONOMIC experts watching Spain don’t know how much money willbe needed or precisely when, but some are near certain that Madrid will eventually seek a multibillion-euro bailout for its banks, and perhaps even for the state itself.

Prime minister Mariano Rajoy has repeatedly said Spain doesn’t need or want an international bailout, and the EU also dismisses such talk.

But economists believe Spanish banks will have to turn to the eurozone’s rescue fund, the EFSF, for help in covering losses caused by a property market crash which has yet to end. Likewise, investors are fretting about how Mr Rajoy’s centre-right government can enforce deep austerity while reviving a recession-bound economy.

“They’re going to need EFSF money to recapitalise the banking sector,” said Carsten Brzeski, a senior economist at ING in Brussels.

“I think we’ll only see a real end to the Spanish misery if the real estate market stabilises.”

Madrid is likely to hold out for some time.

“The underlying picture in Spain is dramatic, but is it dramatic in the way that it needs a bailout package tomorrow? No,” said Mr Brzeski.

“But if you look ahead, let’s say the next six months, I would not be surprised if they [the banks] have to get some kind of European support.”

Market concerns about the eurozone’s fourth largest economy have deepened in the past week. Yields on the government’s 10-year bonds have risen above 6%, a level that has proved a trigger point for other troubled eurozone countries.

At the moment the EU is backing Madrid. Jean-Claude Juncker, who chairs the Eurogroup of eurozone finance ministers, said Spain was taking the necessary steps to get its economy back on track, despite a recession and unemployment at 24%.

German finance minister Wolfgang Schäuble also rejected comparisons with countries which are already on bailout programmes.

“The fundamental data in Spain is not comparable to those in the countries that are under a programme,” he said. “Spain needs to work to win confidence, however, if the positive developments are to continue.”

Markets took fright earlier in the year when Mr Rajoy relaxed targets for cutting the budget deficit.

However, not all economists are so pessimistic and some say the four-month-old government is starting to knuckle down to meeting the new targets. “We’ve seen more progress in a few days than in four months,” said Gilles Moec, a Deutsche Bank economist. “It’s a country that’s intrinsically sustainable, but it’s a country that needs to make decisions.”

Others beg to differ and fear Spain will drag in Italy, which has suffered similar problems with rising borrowing costs.

“As I look at my screen and Spain 10-year yields are up at 6% — things are starting to get worrying again,” said Peter Westaway, chief economist for Europe at Vanguard. “If they go up to 6.5% to 7%, that could become very problematic, and if Italy started to go back above Spain again, then that would be really serious.”

Spain has one thing on its side. It has already raised nearly half the €86bn it needs to borrow from financial markets this year. This means the government could hang on for months before having to turn to the EU for help with its funding needs.

However, that still leaves the banks. One of the critical “unknowables’ for Spain is just how bad a situation its banks are in. The Spanish housing market has been in turmoil for over four years, but prices still haven’t fallen as much as economists think is needed to squeeze the air out of the bubble. Only when prices have bottomed out will assessors be able to calculate just how just much bad mortgage debt is sitting on the banks’ balance sheets, and therefore how much extra capital the sector requires to return it to health.

“Prices have dropped by about 15%-20% from peak to now and they will probably have to drop another 15%-20% before they reach bottom,” said Mr Brzeski. He estimates Spanish banks may need as much as €80bn of extra capital once all bad mortgage debt is accounted for.

In a paper published this week, Daniel Gros and Cinzia Alcidi of the Centre for European Policy Studies estimated the overhang in the Spanish property and construction sector is over €380bn — 37% of GDP.

“A housing overhang per se does not have to lead to an acute financial crisis if it was financed by domestic savings,” they write. “Unfortunately, this is not the case in Spain.”

As a result, economists expect Spain’s banking sector will have no choice but to recapitalise. The government is unlikely to fund such an operation and private investors are reluctant to invest. That leaves the EFSF as the most likely option for the banks and possibly the government.

“Spain is not going to run out of cash [yet] and it’s pre-funded its borrowing requirement,” said Megan Greene, an economist at Roubini Global Economics. “There’s a chance that the banking bailout could come sooner, but I really think it’s going to be next year.”