Spain is one of the PIGS countries: Southern European economies that have been under severe stress during the current financial crisis. However, Spain is overcoming this difficult phase with healthy public figures: the spread of its sovereign debt with respect to the German reference is at about 70 bp, which is at the low end of the range for the PIGS, especially Greece, with a spread above 300 bp.
One of the main reasons for this good behaviour is Spanish fiscal orthodoxy during the last decade: public debt over GDP has been well below the European average. Even now, with a 2009 deficit of 11.4%, most expectations for the next few years give an estimation of public debt at around 80% of GDP, near the average of the expectations for European countries.
However, there are constantly rumours and comments that Spain’s economic situation is worrisome, both for itself and for the future of the European common project. One reason is the sheer size of the Spanish economy: its GDP is more than four times Greek GDP. A financial crisis in Spain, with a default on its sovereign debt would be less manageable than an equivalent outcome for Greece. Additionally, the openness of the Spanish economy, with a big chunk of its debt held by other Europeans countries, could lead to unexpected cascade effects in European countries apparently better insulated from the financial crisis.
Nevertheless, the main argument of this post is a different one: Spain’s main problem is not public debt, but private debt, both for families and companies.
To support my argument, I want to show the following charts regarding public debt and private debt, both for families and companies:
Spain, as it has been described above, has a low level of public debt, even though its late increases are worrisome. For example, it is still well below the levels of France and Germany, and much below Italy. In fact, one could consider this growth of public debt as a convergence towards the European average, and as such, not excessively problematic.
The biggest issue for Spanish indebtedness is within families and, especially, companies. Corporate debt is the highest for all the considered countries in the study, and for families, debt is only below the American one, and in line with the British one. However, corporate debt in America is quite low, which leads to the conclusion that total private debt sustainability is more an issue in Spain and the UK than anywhere else.
France and Germany show a remarkable European convergence trend: their debt paths are almost parallel, both for corporate and public debt. The main difference is for family debt, which shows a convergence, much weaker than in the other cases, but a convergence nevertheless. Probably, the reason is a demographic one.
Finally, Japan shows the terrible consequences of allowing a financial crisis to extend indefinitely in time, while keeping „undead” those „zombie banks” that should have economically defaulted: while private debt has plunged, public debt has exploded, unable to force companies and families to increase its demand of credit.
The Stability and Growth Pact forces all European countries to be below a 3% public deficit in 2013. As a consequence, the Spanish government has put in place a government program to reach this target. It is not clear at all that this objective will be accomplished (the plan has not many details on how the spending cuts will be allocated, and the growth expectations for the Spanish economy are too optimistic for most analysts). However, one could estimate which would be the economic contraction due to this fiscal retrenching. Some analysts, assuming standard fiscal multipliers, have argued that the impact for the following years could be a whopping 16.5% for GDP.
To sum up, Spain is under the following structural forces for the following years:
– Contractionary monetary policy: the European Central Bank is phasing out its extraordinary liquidity measures („enhanced credit support”) during this year. Analysts and markets consider the marginal refinancing rate will start an upward move from its current 1% at the end of 2010 or the beginning of 2011 at the latest. Let me stress almost all Spanish mortgages are variable rate, which leads to much stronger responses to the Spanish economy from the monetary policy side. The reduction from 4.25% to the current 1% has been a huge stimulus for the Spanish economy. My personal calculations tell me the impact of monetary policy has been more than three times stronger than all fiscal policy measures together.
– Contractionary fiscal policy: as we have discussed above, Spain is bounded, by the Stability and Growth Pact, to implement contractionary fiscal measures which will probably lead to an overall contraction in GDP in the double digit camp. Economically, this does not make much sense: the public sector has still room to become more indebted (we have argued before the overall level of public debt in Spain was still relatively low), especially when it is the private sector the one that is too indebted.
– Banking system: past Spanish governments boasted that Spain had „the most resilient banking system in the world.” However, this attitude has led to the resistance to implement reforms that have been deployed in most European countries during this crisis. This has induced to the build up of more and more imbalances for Spanish Banks and Savings Banks. This will be the subject matter of following posts in this blog. Suffice to say that the Spanish banking system is in a weak position, and the flow of private credit is already with negative rates.
To sum up: even though it is true that the Spanish public sector is still in relatively good condition, with contained spreads, the main issue for the Spanish economy is its private debt, unlike other PIGS countries.
The main task for the Spanish economy is then to become more competitive: once fiscal and monetary policy cannot become expansionary anymore, growth has to be generated internally. Reforming the job market will be an essential part on this task. More on this subject, in the next posts in this blog.
The following months and years will be key to find out if Spain will be able to refinance and finally pay out the huge amount of private debt that has been assumed due to the massive construction bubble of the past decade.