This is a question everyone needs to be worried about. We can all recall the turmoil in global financial markets when Greece fell into a debt crisis. Well, that would look about as exciting as a sing-along with Barney if Spain experienced a similar meltdown. Spain is a much, much bigger economy, the world’s 9th-largest in fact, and the ripple effects from a Spanish debt crisis would have very serious consequences around the world.
Investors have clearly been concerned with Spain’s fate. The spread on yields between Spanish and German sovereign bonds – a key measure of perceived risk – has been rising and reached its widest level since the introduction of the euro mid-week (though it later narrowed). Then it appears that Spanish banks and companies are having a harder time raising funds. According to The Wall Street Journal, Spain’s treasury secretary admitted credit was tightening for the country. This is a worrying sign of where sentiment is going on Spain.
But when you crunch some numbers, it quickly becomes apparent that Spain is NOT Greece. Spain’s circumstances are quite different. And you begin questioning why markets have been so jittery about a Spanish debt crisis.
The most obvious difference with Spain is its level of sovereign debt. The Spanish government is just not burdened as heavily by debt as many of its peers in Europe. According to OECD data, Spain’s ratio of government debt to GDP (under 63%) is significantly lower than either Portugal’s or Greece’s (and for that matter, is below France’s and Germany’s, the giants of the euro zone and supposed pillars of strength). Nor does Spain have a record of fiscal profligacy like Greece. Just the opposite. The government posted a budget surplus as recently as 2007 and has historically been one of the euro zone’s most fiscally responsible citizens.
An official at Standard & Poor’s told me this week that she believed the markets are “overshooting” in their concern about Spain’s solvency (even though the agency downgraded Spain’s sovereign rating in April). Her opinion is far from unique. Barclays Capital, in a recent report, figured that Spain is less vulnerable to a debt crisis than Greece, Portugal and even Ireland.
So what are investors looking at? Spain does have its vulnerabilities. Its fiscal situation has deteriorated quickly and the deficit is large. The economy is in serious condition. One out of five workers in Spain are jobless, and the International Monetary Fund is forecasting the economy will continue to contract in 2010. Then there is the stress-inducing level of debt in the private sector, at 178% of GDP, according to S&P, and the strain a major housing bust is putting on the nation’s banks. There’s a possibility that the combination of these economic woes will continue to put pressure on state finances. So yes, Spain has its problems.
But it does also seem that Prime Minister Jose Luis Rodriguez Zapatero is working at solving these problems by implementing the reforms investors are demanding. He’s already put budget cuts in place in late May to reduce the deficit. And this week, his cabinet approved a labor reform bill to encourage hiring and make the labor market more flexible. This is a very, very important reform for the economy, one economists and businessmen say is absolutely crucial to reduce unemployment and eventually get growth going again. Much more needs to get done (like financial sector reform) and there are challenges ahead (including an upcoming parliamentary vote on the labor reform package, the outcome of which is uncertain). But Zapatero is at least moving in the right direction and should be given the credit for that.
Perhaps most importantly, Madrid has shown it can still count on international markets to raise funds. Market jitters were calmed on Thursday after Spain managed a better-than-expected sale of more than $4 billion in bonds. Here’s what Carl Weinberg of High Frequency Economics said about that success:
Markets are breathing a sigh of relief that Spain can approach the markets for funds and get what it is looking for, which is adequate funding at affordable – if higher than they would like to see – rates.
He went on to conclude:
Spain’s biggest problem is that markets are retracting from all risk…Reason suggests that funding its deficit should be no problem, and that there should not be a crisis…We are optimistic that reason and elemental financial analysis will prevail here, and that Spain will not go the way of Greece.
I hope so. My concern is that investors are so nervous about a debt crisis in Spain that they’ll act in ways that make their own worst fears come true. We’ve all become too aware of the danger we face when financial markets get seized by panic. Then facts mean little. Let’s keep our fingers (and everything else) crossed that investors this time around will think with their heads and their calculators, not their emotions.