Spain is likely to request financial help within the next few weeks. Thanks to the involvement of the ECB, the bail-out does not need to be very large to be efficient. The expected easing of borrowing costs should indeed make it possible for Spain to keep on raising funds on financial markets. We now wait for further details from the ECB on how it intends to act
- It became obvious that Spain would have to request help from its European fellow States earlier this year, when the positive effects of the ECB’s 3-year LTROs on sovereign yields faded away. Financial markets’ expectations of an incoming full bail-out further increased in June, when it was announced that Spanish banks would be recapitalised with European money. This positive piece of news failed to lower Spanish yields. For sure, and even if temporarily, the money lent by the EFSF was to increase the State’s indebtedness ratio, while the (de facto or de jure) seniority of European bail-out funds actually led to increase the perceived risk faced by private creditors. Still, the necessary recapitalisation was met at a lower cost.
- The banking sector is just one problem among others. The other main issue is the uncontrolled budget deficits of autonomous regions. For the Spanish government, regaining control is not possible directly (it would require to rewrite the Constitution). It however introduced measures to give autonomous regions additional incentives to clean up their finances. First, a framework was introduced for regions failing to meet their quarterly budget targets. They now have six months to present a consolidation plan, after which, if the plan is judged insufficient, the central government takes over financial management and imposes the necessary cuts. Second, two liquidity funds were created. The first, the Fund for Financing Payments to Suppliers (FFPP, EUR 35 bn), has been set up for regions unable to fund deficits or pay debt to suppliers. The second, the Autonomous Community Liquidity Fund, has been set up to help autonomous regions facing difficulties in refinancing maturing debt. The mechanism will be funded by the General State Budget (EUR 12 bn) and an extraordinary dividend from the state lottery (EUR 6 bn). Those two funds basically work like the European bail-out funds: distressed autonomous regions ask for help and get cash but are then subject to strict fiscal and financial conditionality.
- These two funds, while insuring a smooth financing of autonomous regions, will however add to the Spanish government financing needs. This comes on top of a deterioration of finances of the central government. Over the first half of 2012, budget deficit reached 4% of GDP versus 2.5% in 2011 H1. Excluding transfers to regions, it stood at 3% versus 2.4% a year earlier. In short, even at the central level, public finances are deteriorating. This is no surprise, though. The Spanish GDP was down for the third quarter in a row in 2012 Q2, by 0.4% q/q, following 0.3% in both 2012 Q1 and 2011 Q4. This resulted in a drop in tax collection, with a particularly marked decline in VAT receipts (-10% y/y). This also led to another increase in the unemployment rate, which reached 24.6% in Q2, and drove unemployment and other social benefits up by 4% y/y.