5 reasons for Spain’s colossal economic troubles

Jul 24, 2012, 3:47 PM

Associated Press

MADRID (AP) – Spain’s financial crisis is a lot like peeling an onion: remove one troubled layer and you expose another.

Repeated efforts since 2009 by successive governments to fix the country’s problems have managed to undermine confidence in the fourth-largest economy among the 17 nations that use the euro.

A recession is deepening in Spain and a growing number of its regional governments are seeking financial lifelines. These developments are adding to the problems of a government already struggling to prop up its shaky banking system.

Spain’s main IBEX stock index has lost 3 percent over the last three days while the government’s borrowing costs for its debt have soared to their highest levels since the country joined the euro in 1999.

Last Friday, Spain finally got approval from the other 16 members of the eurozone to access up to (EURO)100 billion ($121 billion) in loans to prop up its banks which are weighed by down by (EURO)180 billion in soured real estate investments.

Spanish officials had hoped a solution for the banks would ease some concerns about the state of the country’s finances and prompt investors to stop demanding unmanageably high interest rates for government debt. Such high rates forced Greece, Ireland and Portugal to seek full-blown public finance bailouts.

But instead of easing off, investors panicked again.

On Monday the country’s central bank said that the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as a growing number of regional governments that function like U.S. states ask federal authorities for assistance.

By Tuesday, investors had sent benchmark borrowing rate for Spain’s 10-year bonds to 7.53 percent, just the latest in a series of records. By contrast, Germany’s is just 1.26 percent.

If Spain’s borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue that would push Europe’s rescue funds to breaking point.

Here are five reasons investors are scared about Spain:

HURTING REGIONAL GOVERNMENTS

During Spain’s property boom, the country’s 17 semi-autonomous regions raked in unprecedented revenues from building permits and fees. They windfall to finance infrastructure projects and the ranks or public employees swelled. Across Spain, highways, parks, public swimming pools, gleaming government buildings and airports sprung up.

Now the property market has collapsed and the regions can no longer afford to pay their bills and manage their debts.

The regions’ problems have been a focus of investor concern for more than a year, but the fears skyrocketed last Friday when the region of Valencia announced it would be the first to tap a federal fund set up to bail out the hurting regions. Over the weekend, the region of Murcia said it also needed help.

More regions are expected to join the queue, threatening to overwhelm the central government. No one knows how much money the regions will need, though leading newspaper El Pais said they have combined debts of (EURO)140 billion and that (EURO)36 billion must be refinanced this year.

The fund set up by the government on July 13 will have (EURO)18 billion in capital, part of it raided from the national lottery. If more funds are needed, Spain would either have to issue debt at punishing rates _ or ask for a bailout.

WEAK GROWTH PROSPECTS

While one out of every four Spaniards are unemployed, the rate for job-seekers under 25 stands at 52 percent. Emigration by young adults is on the rise, and companies are taking advantage of new labor reforms that make it cheaper to fire workers. The country is in its second recession in three years.

Just as Valencia was announcing its financing needs last Friday, Spain’s finance minister revealed that the economic contraction will be deeper than expected in 2013 _ meaning an even longer period of economic pain before Spain can hope to start generating jobs again.

For this year, the government expects a smaller contraction than previously forecast of 1.5 percent, down from a previous estimate of 1.7. However, instead of economic growth of 0.2 percent for next year, the government now forecasts a contraction of 0.5 percent.

BANK BAILOUT WORRIES

The concerns circling Spain’s shaky banks intensified in May when Bankia, the country’s fifth-largest lender, unexpectedly announced it would need (EURO)19 billion to cover its toxic property loans and assets. A month later, leaders of the other 16 countries that use the euro crafted a rescue package of up to (EURO)100 billion for Spain’s banks.

Spain still hasn’t put a precise figure on how much the banks will need, denying investors a clear picture of the extent of the problem and whether the (EURO)100 billion is enough to handle it. Those numbers won’t start coming out until September when extensive audits and stress tests of each bank are finalized.

Friday’s announcement by eurozone finance ministers that they had agreed the terms of the bailout hasn’t quelled markets. That’s because the government is ultimately liable to repay the loans. Europe’s financial leaders agreed in principle earlier this month to eventually make loans directly to banks and take the Spanish government out of the equation. But that shift is a long way off _ a pan-European banking authority would have to be created first and that could take years.

There is also concern that the rules of the bailout mean that eurozone would have to paid back first before other debt is settled. This could leave less money for private investors.

DEBT DEPENDENCY

The bank bailout has only made investors more worried about Spain’s financial position.

Two-thirds of Spain’s government bonds are held by the country’s banks, pension funds and insurance companies _ that’s 50 percent higher than last year. This sharp increase is a sure sign that foreign demand for Spanish debt is falling fast.

Market-watchers are concerned that Spain and its banks are dependent on each other: the government is issuing debt, the majority of which is being bought by its banks, only to use the funds from the sale to prop up its banks so that they can buy more government debt.

Spain has so far this year issued (EURO)59 billion in bonds out of a total (EURO)86 billion planned for 2012. But as the banks’ condition deteriorates, there is growing concern that they won’t be able to buy up much more government debt.

GROWING PUBLIC ANGER

Since beating former Socialist Prime Minister Jose Luis Rodriguez Zapatero in the polls late last year, Prime Minister Mariano Rajoy has been introducing successive rounds of austerity measures aimed at preventing the country from being forced into a public finance bailout.

Rajoy’s latest set of measures has been his most controversial _a steep hike in Spain’s sales tax, and the elimination of one of the 14 yearly paychecks that public servants receive.

Spain has been spared the level of brutal anti-austerity street violence like that seen in Greece, but got a taste of it on July 11 after Rajoy unveiled the new round of cuts and tax rises. Spanish miners and sympathizers, incensed with the seemingly endless cutbacks and tax hikes, clashed with riot police who fired rubber bullets, injuring 22 demonstrators and 10 officers.

The miners said cuts in government mining subsidies will leave them jobless, and many Madrid residents joined in because they believe the problems that the miners face are similar to their economic woes.

Off-duty police and firefighters are starting to join in anti-austerity protests by public servants. Officers are prohibited from wearing their uniforms while protesting, but deck themselves out in white shirts to identify themselves, and the firefighters hold their helmets.

If future protests come with escalating violence, that would only make investors more nervous about Spain.

(Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.)

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5 reasons for Spain’s colossal economic troubles