Sun, Nov 28, 2010 - Page 9 News List

Already burdened, Europe now worries about Spain’s economy

Even though Spain has reduced its deficit, concerns that it could need a bailout remain

By Raphael Minder  /  NY Times News Service, MADRID

Europe so far has survived the bailout of Greece. The financial rescue of Ireland is also manageable. Even if Portugal becomes the third country to succumb and seek aid, as many people widely predict, it is unlikely to push Europe to the financial brink.

However, any bailout of Spain — with an economy twice the size of the other three combined — could severely stress the ability of Europe’s stronger countries to help the financially weaker ones and spell deep trouble for the euro, Europe’s common currency. Even though Spain, like Ireland, has adopted an austerity plan to help it avoid the need for a bailout, it could still need aid if its banking system proves frailer than the government thinks it is, as was the case in Ireland.

This troubling scenario has unnerved lenders, with Spain’s borrowing costs rising even though Madrid has cut its deficit and the country’s banks maintain they have sufficient strength to absorb their real estate bad loans.

“Europe can afford the collapse of Ireland, even perhaps that of Portugal, but not that of Spain, so Spain’s ultimate line of defense is in fact this knowledge that it’s too big too fail and that it represents a systemic risk for the euro,” said Pablo Vazquez, an economist at the Fundacion de Estudios de Economia Aplicada, a research institute in Madrid.

Reflecting the worries of investors, the yield spread between Spanish 10-year government bonds and those of Germany continued to widen on Wednesday — to as high as 2.59 percentage points, the biggest gap since the -introduction of the euro. Spreads typically widen when investors perceive greater risk of repayment.

The problem for Spain is one of “self-fulfilling expectations,” said Jordi Gali, director of the Center for Research in International Economics at Barcelona’s Pompeu Fabra university.

“If investors expect Spain to have trouble refinancing its debt, now or somewhere down the road, then Spain will have trouble,” he added. “This is only aggravated by the fact that the reluctance of investors to purchase the country’s public debt leads to an increase in the interest rate it has to pay and thus in the budget deficit and the amount of debt it has to issue.”

Spanish Finance Minister Elena Salgado insisted on Wednesday that Spain would not need rescuing. She told Spanish radio that “we are in the best position to resist against these speculative attacks.”

Indeed, some say that one of Spain’s relative strengths is that a large amount of its government debt — 203.3 billion euros (US$271.1 billion) — is owed to its own banks, rather than foreign lenders. If the government’s financial condition worsens, the thinking goes, Spanish banks would have a greater incentive to help out by easing terms on the loans than would foreign banks, which might take a harder line.

Of course, it is a bit of a double-edged sword; if the Spanish banks need to ease terms to help the government, they could be forced to swallow steep losses, hurting their balance sheets.

The likelihood of entering such a vicious circle could also rise next year, when Spain is due to repay lenders 192 billion euros, or about a fifth of the total debt. As a result of increasing interest it would have to pay for new borrowing, Spain faces a rise of 18 percent in the cost of financing its debt, according to the government’s budgetary plan.

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