Daniel Korski

Iberian blues

Iberian blues
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I’m finishing a two-day trip to Spain and am about to board a plane, just as the bond markets turn their attention to the Iberian Peninsula. As James wrote yesterday, the gap between Spanish 10-year government bonds and those of Germany has widened to as much as 2.59 percentage points - the biggest gap since the introduction of the euro.

For its part, the Portuguese government said it was under no pressure from the European Central Bank or other Eurozone member-states to accept financial aid to ease its debt and deficit problems. That sounds like the noise before the defeat.

Portugal was brought to a halt yesterday by a strike in protest at the government’s spending cuts and tax rises, which aims to reduce the budget deficit from 9.3 percent of GDP to less than 3 percent by 2013. The reforms, however, may not be enough to assuage the markets and put Portugal back on the road to recovery. Even before the crisis, Portugal struggled to grow, achieving less than 1 percent on average in real terms in the last decade. The Portuguese government will need to push through reforms, including changing the collective bargaining process, cutting severance payments, selling-off state-owned assets and reducing public wage levels.

Reform will also have to take place in Spain. But, as The Economist has written, the Spanish Prime Minister “has shown no real understanding of the need for reform”. Fortunately, the situation is not as bad as in Greece, Ireland or Portugal. Government debt is half Greece’s level and the liabilities associated with the Spanish government’s support for its banks are less than 5 percent of GDP, which - when compared to Ireland’s 176 percent of GDP - does not look so bad. The large Spanish banks BBVA and Santander are thought to be healthy and have large Latin American assets that can be sold-off.

Yet Spain has a number of problems. The economy was built on the bust real estate bubble, which is now affecting the rest of the economy. The unemployment rate nears 20 percent, with only 58 percent of people in the 16-64 year age group actually employed. Private sector foreign debt stands at over 100 percent of GDP. Finally, the Spanish banks, while deemed healthy, could suffer if Portugal’s financial crisis deepens. Spain is Portugal’s biggest trade partner, it is also its biggest creditor, with Spanish banks owning $78 billion of Portuguese debt.

Spain could also suffer if Prime Minister José Luis Rodríguez Zapatero shirks from undertaking the necessary reforms. On his past record, this is a likely scenario.