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Spain - contagion, unemployment & everything else

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Date
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12/03 2015

The problems in Spain

Some startling figures on Spanish unemployment prompted a discussion here at FinanceInterns HQ on exactly what problems Spain faces right now. We’ve all heard that Spain is suffering some serious economic and social problems including high borrowing costs and high unemployment... but just how bad is their situation? And why did Italy’s stalemate elections on 24 spreading to other southern European countries, including Spain?

FinanceInterns provide you with the answers and stats you need

Wed 27th meeting in Brussels of European Union leaders saw a document circulated that said: “Social Europe is in trouble. It is... dangerous for the very future of the European Union. If we do not succeed in showing that Europe brings about training, employment and social progress for citizens, important conditions for the legitimacy of the European project will be jeopardised.” (CNBC/Reuters)

Unemployment

Unemployment is at a record high of 11.7% in the Euro Zone, and 10.7% in the European Union for December. There have been protests in Spain, Greece, Portugal and Belgium – Spain and Greece both see youth unemployment exceeding a disastrous 50%. The situation is so bad that the EU have discussed introducing guaranteed jobs or training within 4 months of leaving school in a “Youth Guarantee” programme, to prevent losing a generation to unemployment or migration as young people give up hope and just live off the state and their families, or move to countries where the job prospects are better.

For example, with Spain’s unemployment at 26%, or 60% among young people, and Germany seeing the strongest level of employment since 1990’s reunification (just 6.8% unemployment nationally), there are reports of an influx into boho Berlin of young Spaniards.

Other indicators of Spain’s problems

Aside from high unemployment, there are myriad factors pointing to Spain’s economic woes. Spain’s output fell 0.8% in Q4 of 2012, its sharpest quarterly drop in nearly 4 years. Recent corporate earnings for the majority of Spain’s IBEX 35 index were the worst in years, with Bankia reporting Spain’s largest loss in corporate history (€19.2bn) after a real estate market collapse which left many of its banks insolvent. Analysts expect more lay-offs to come, and further mortgage defaults as government cuts to public salaries and health and education spending take effect.

To bail-out or not to bail-out?

Only last year, the country was on the verge of bail-out, assuaged only by ECB bond-buying, and prevented by Spain’s reluctance to ask for aid amid worries Catalonia, Spain’s richest state, may break away.

The ECB’s Outright Monetary Transactions (OMT) plan of September 2012 saw the ECB promise potentially unlimited buying of a struggling country’s bonds. Remember, sales of a country’s sovereign bonds are crucial as it is how, alongside tax revenues, that that country raises money, to be spent on welfare, infrastructure – everything the population needs. If there are fears for the country’s creditworthiness i.e. its ability to pay back the money borrowed via the bonds, to the bondholders, then the interest rate (the yield) that the buyer th and 25 th February, immediately spark fears of ‘contagion’ of the bond demands is higher meaning that it costs more for that country to sustain itself.

The ECB’s OMT vow saw a calming of the market for Spain’s bonds. However, the ECB will only buy a country’s bonds if they sign up to a European aid programme with debt-cutting conditions attached – the so-called ‘austerity measures’. With Italy’s population having voted for parties who pledge to halt or even reverse their economic reforms, they have effectively done away with the safety net of the ECB’s OMT bond-buying programme. Italy failing to uphold their side of the bargain, means Germany’s Bundesbank, the biggest stakeholder in the ECB, would certainly disapprove of any bond buying – the ECB would effectively just be printing banknotes for a country that was doing nothing to get themselves out of trouble. Consequently, European leaders are having to watch and wait to see whether a strong government can emerge out of Italy’s election mess, or whether borrowing costs spiral, without the ECB’s intervention, at least forcing Rome to deliver on austerity measures. This latter option would destabilise markets however.

Medium term & short term contagion fears

The fear is that Spain could be the next to suffer political instability in the medium term thereby also compromising its ability to deliver much-needed spending reform. A country in domestic distress, where protests are already happening on the streets of Madrid at unpopular austerity measures from Prime Minister Rajoy and exacerbated by unrest over political and Royal corruption scandals, could see its people reject its ruling parties, as the populace have in Italy.

In the short term, the big fear is ‘contagion’: any spiral to Italy’s borrowing costs may spread to Spain’s too as Italian and Spanish bonds have tended to move in tandem. Spain’s economy is over twice the size of Portugal, Greece and Ireland’s economies combined – a huge burden for the ECB to support if that becomes necessary. Like with Italy however, the ECB may not be able to buy up any bonds if Spain cannot commit to an austerity package due to potential election of a party which opposes such reforms. What then for the euro?

So, what's next?

Spain is set to issue new bonds next week, week beginning 4th March. All eyes will be on how much Spain manages to auction, and the yields (interest rates) buyers demand.
 

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