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Spain: The Crisis Front Some May Have Forgotten

Spain: The Crisis Front Some May Have Forgotten

Yohay Elam, Technical Strategist

Italy is now garnering much of the attention in the Eurozone, but with Spanish debt still mounting despite controversial spending cuts and stimulus measures, a bailout seems increasingly unavoidable.

Spain, the euro-zone’s fourth largest economy, maintains access to the bond markets, but this comes at a price: Spain paid €38.66 billion in interest payments on its debt, and for the first time ever, the nation’s financial costs have exceeded staff costs. This serves as a sobering reminder that without a return to growth that will raise revenue, Spain is unlikely to avoid a bailout.

The commitment of the European Central Bank (ECB) to do “everything to preserve the euro” in July 2012 certainly helped the struggling nation. It contributed to lowering the country’s bond yields in the secondary market, as well as in the primary market.

ECB president Mario Draghi followed up on this commitment by presenting the Outright Monetary Transactions (OMT) program. According to this program, the ECB would buy bonds of troubled countries, provided they took a bailout. The commitment of the ECB served as a bazooka: Investors knew that the ECB was ready to act, and as a result, they felt more confident investing in Spain. And although Spain paid a lower interest rate in consequent bond auctions, this is probably not enough to save the nation from its debt.

Debt Rises Despite Deep Cuts and Tax Hikes

In September, the top rate VAT level rose from 18% to 21% and the medium level rose from 8% to 10%. In addition, services such as movie tickets and haircuts were moved from the lower tax rates to the higher ones.

During 2012, the government of Prime Minister Mariano Rajoy made cuts in health and education, triggering mass protests. The cut in pensions could eventually hurt the unemployed who rely on pensions of their relatives, which would likely force even more citizens to take to the streets. (Read more about Spain’s impending pension problems on Forex Crunch.)

Tax revenues would have been higher if the economy had grown. Yet here also, the data points in the other direction: Spain’s economy contracted by 0.8% in Q4 and by 1.9% year-over-year, according to the most recent data.

However, despite these deep spending cuts, tax increases, and improving market conditions since the summer of 2012, the debt-to-GDP ratio rose well above the government’s target. Spain’s total debt grew by a total of €146 billion, to €882 billion at the end of 2012. The debt-to-GDP ratio is now 84%, still above the 79.8% forecast the government presented in July 2012.

One of the reasons for the growing Spanish debt is transfers to banks. Bankia, which became a symbol of Spain’s banking issues, was nationalized in May 2012 and reported a loss of €19.06 billion that year. Spain received €41.4 billion in aid for its banks, but not for the state itself. Spain did not receive visits from the “troika”—the EU/ECB/IMF coalition—like Greece, Ireland, and Portugal did.

The political stalemate in Italy and the market reaction showed that the Eurozone crisis never really went anywhere. Spain’s borrowing costs were not optimal, and the elections in neighboring Italy have again shown that Spanish bonds are very vulnerable.

As a result of these ongoing factors, Spain could still find itself asking for a bailout in 2013, and this would have an obvious negative impact on the euro and major pairs like EURUSD and others.

By Yohay Elam of Forex Crunch

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.