Spain shrinks its way to growth
JAMES SAFT
Shrinking your way out of a debt crisis is difficult.That’s not stopping Spain from trying, as it piles spending cut upon tax increases in an attempt to appease its lenders, while at the same time staying in the economic straitjacket its euro membership represents.
Spain’s government deficit may top 8 percent in 2011, far above expectations. This compares to a 6 percent target the previous government had pledged to meet, something that will disappoint both Spain’s European partners and financial markets.
The government’s knee-jerk reaction to this state of affairs was to unveil 14.9 billion euros of spending cuts and tax increases, freezing some government salaries and imposing new burdens on the better off. How exactly this, and more like it to follow, will help Spain to reduce its debt remains to be seen.
Spain’s problems are not complex: its public and private debts are too high and it is not terribly competitive, either globally or within the eurozone, giving it little scope for balancing its books by growing its revenues.
To make matters worse, Spain’s opiate of choice this past decade was unneeded real estate development, and even if it has now kicked that habit its banking system is shaky enough that it is not really fulfilling its role, further stifling the economy.
Really we have been here before, in Thailand, Argentina and Iceland to name but a few, and the script usually plays out in more or less the same way; devaluation and sometimes default follow denial and, after a time recovery flowers.
The problem, of course, is that Spain as a member of the eurozone cannot follow that pattern, at least not without causing a global economic tsunami.
Here is the thing about Spain - it is not competitive.
Spanish unit labor costs probably have to decline by more than 20 percent to regain competitiveness internationally. The only way to achieve that without devaluing your currency is to increase productivity or cut wages. Increasing productivity involves investment in technology or processes, something that Spanish companies are going to find tough to do, even if they were brave enough to want to invest into a downturn. There are also serious question about whether Spain’s banks can or will make the loans needed to improve productivity. At this point they are more concerned with surviving.
Deflationary logic
So, we are down to wage cuts for workers in Spain. That can happen, of course, but workers will pay less in taxes and spend less. Thus we return to the self-fulfilling part of the eurozone crisis. As Greece has demonstrated, economies which are put on diets tend to shrink. Labor market reforms and other measures can help over time, but perhaps not quickly enough to satisfy Spain’s current creditors.
Spain is getting help. The European Central Bank (ECB) is buying its bonds, and, importantly, those of Italy, on the secondary market, and the central bank has opened a very long-term refinancing program that will help Spanish banks. Surviving, however, is a lot different from intermediating capital, and the signs are that Spanish banks are doing a lot less of that. Lending fell 2.5 percent in October from a year earlier, following a record 2.6 percent drop in September, according to Bank of Spain data.
Spanish banks need to refinance about 130 billion euros of loans in the coming year, far higher than in 2011, as loans taken out under an emergency three-year government guarantee program in 2008 come due. And while non-performing loans have hit a crisis-era record of 7.4 percent of loan stock, there are real questions about how forthcoming the banking system is being about their portfolios’ actual value.
Repossessed houses in Spain are worth 43 percent less than the valuations they are assigned on their mortgage, according to an analysis by Fitch Ratings. While those loans are not owned by banks, the data imply a real hit to bank capital as the housing slump grinds on, as it most certainly will.
So 2012 for Spain means a recession, deflationary forces unleashed on wages and a credit crunch. All that remains is for markets to decide, as they seemed to do a month ago, that these forces would outweigh Spanish and European resolve. As it stands Spain’s 10-year debt yields 5.09 percent, down from 6.60 percent in November.
In truth Spain might ride it out, might with support and through suffering struggle through several lean years and emerge with its currency and society intact.
(This abridged column was originally published by Reuters)
