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Spain: Too big to fail?

Greece, Ireland and now Portugal. Debt-ridden, deficit-laden and bankrupt were it not for bailouts from abroad. Spain is the fourth and final letter in the hackneyed PIGS acronym for Europe’s struggling economies. It is also the biggest, and its economic future will decide the fate of the euro zone.


Spain's economy is more robust than the bailed-out countries, but it's also much bigger. Image: European Weekly.

The European Union’s three victims-so-far of the global financial meltdown have, not incorrectly, been described as the economic bloc’s periphery. Their economies are relatively small and, though at times worries about their debts have undermined the euro currency, their problems – even taken in combination – are hardly likely to bring the bloc to its knees. Individually, they were sick from a debilitating cocktail of similar problems: bed-ridden with debt and weak from a bad diet of profligate government spending and loan-happy banks. Nothing, it seemed, that a dose of bailout money from the EU and IMF could not cure with a trip to the emergency ward.

Spain is showing similar symptoms. Though what appeared to be a bad, but probably curable, cold for Greece, Ireland and Portugal, could, in Spain’s case, become a highly contagious flu – disastrously debilitating not only for the country itself but for the euro zone as a whole.

As the world’s 12th-largest economy and the fourth-largest in the euro zone, Spain’s GDP is twice that of Greece, Ireland and Portugal combined. And while the Greek, Irish and Portuguese bailouts totalled approximately €275 billion, many economists estimate that if Spain loses its ability, like the other PIGS, to borrow from the international markets at affordable rates, it would need a loan package worth anywhere from €350 billion to €450 billion. Citizens of countries, from Germany to Finland, who are already footing the bill for the Greek, Irish and Portuguese bailouts are unlikely to take kindly to the idea of having to cough up even more money to save Spain.

“A bailout of Spain would not only strain the capacity of the European Union bailout fund, it could also lead to a massive political backlash from angry citizens in the creditor countries,” notes one economist. “Historically, the number of countries that have been able to overcome debt and competitiveness-related problems without resorting to currency devaluation and/or debt restructuring is exceedingly low.”

That is one reason why Greece has recently been rumoured to be considering dumping the euro in favour of a return to the drachma in what would effectively amount to a debt default. Greece departing the euro would not necessarily mark the end of the single currency, but were a country with an economy the size of Spain to seek a similar way out, the euro may well end up being remembered as little more than an interesting experiment in monetary union that went awry.

Hammed in by the euro

In a broad sense, the introduction of the single currency a decade ago can be blamed for the current predicament facing the PIGS.

It’s a familiar story: With the adoption of the euro, countries lost the ability to set interest rates themselves, handing that power instead to the European Central Bank, which dictates rates for the entire bloc, though not necessarily in the best interests of all member states. Germany, being the biggest economy in the euro zone by far, had the most influence on rates, and, for much of the last decade, its economy wasn’t growing very fast. The ECB therefore kept rates low.

However, over the same period, countries like Spain, Greece and Ireland were booming and they would have benefitted from higher rates to keep their economies from overheating.

In the case of Spain in particular, low rates helped inflate a property bubble as consumers and developers borrowed more money on the cheap to build and buy increasing numbers of ever more expensive houses coming onto the market. By 2007, construction and real estate in Spain accounted for 13.3 percent of employment and 11.9 percent of GDP. Real estate prices in Spain more than doubled in the decade before the bubble burst, and when it did, coinciding with the global financial meltdown, it dragged the rest of the economy with it. Unemployment surged as jobs in the construction industry and related sectors vanished, government tax revenues fell while social expenditures rose, and banks were left holding billions worth of bad mortgages and unsellable real estate assets.

The threat of further collapse

Officially, Spanish property prices have fallen by around 20 percent – and as much as 40 percent in some coastal regions – since the credit crunch in 2008, though with around 700,000 homes reportedly sitting empty across the country and little demand from cash-strapped workers, the worst for the property sector may not yet be over.

Banks are keeping many of these properties on their books in order to avoid flooding the market with repossessed houses, which would trigger an even sharper fall in prices and make their balance sheets look even worse than they currently do.

Banks and savings banks hold about €150 billion in problematic loans linked to real estate – equivalent to 15 percent of GDP – and the government has recently forced banks, particularly the especially debt-ridden savings banks known as ‘cajas,’ to raise their capital to among the highest levels in Europe in a bid to reassure investors about the stability of the country’s financial system.

In addition, the government is pushing through austerity measures to get public sector spending down and increase economic competitiveness. And, as government officials repeatedly stress, Spain’s public finances could be a lot worse: public sector debt is around 70 percent of GDP – roughly 20 percent lower than the euro zone and less than half the ratio of Greece.

That helps explain why Spain has not been treated as harshly as the other PIGS on international debt markets. The cost of 10-year borrowing for Greece is 15.5%, for Portugal it is 9.5% and for Ireland it’s 10.4%. Spain, however, is still around 5.2%.

But with private sector debt running at 150 percent of GDP and the ECB likely to continue raising interest rates thanks to the current strength of the German economy, Spain’s economic malaise is likely to remain under close scrutiny for some time yet. The health of the whole euro zone will depend on it.

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Published: May 12 2011
Category: Business
Republication: Creative Commons, non-commercial
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4 Comments for “Spain: Too big to fail?”

  1. Do you not mean “hemmed” in by the Euro?

  2. Micahel Clarke

    Sir, You write, “Unemployment surged as jobs in the construction industry and related sectors vanished” , Quite true! I wish the foreign press would report how many of those jobs were not done by Spaniards to begin with. The FT, BBC, et al. keep citing the high unemployment rate here, but forget to point out how many of these people were illegal immigrants, (from South America, Morroco etc) who were “Legalized” by Zapatero in the mid-noughties (much to the consternation of other E.U. countries). Now we the Spanish tax-payers are paying the brunt for still having them around.

  3. You need to do a bit of research Michael, those immigrants who were legalized started paying social security contributions which help to pay the pensions of many Spaniards, taxpayers or not. Of course for the employers it was always better that they had no rights. The immigrants who were legalized were here under Aznar’s government too, but completely unprotected against exploitation. A recent report demonstrated quite clearly how the Spanish state has benefited economically from immigrants (whose education they never had to pay). If some of these are now entitled to unemployment benefit it’s only because they’ve paid their contributions in the same way as any other taxpayer. I’m a taxpayer in Spain too and the people I pay for are those (often wealthy) people who manage to avoid paying taxes at all.

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