Monday, November 22, 2010

The difference between Spain and Ireland is timing

So Ireland finally caved in and went to the EU and the IMF for a loan. The point for Spain though, is will they eventually be brought down by the same pressures that did for the Irish?

The consensus appears to be no it won't. The markets and most commentators seem to accept that Spain is a different proposition and can pay its way. At an important bond auction last week, in the midst of the Irish uncertainty, Spain did manage to sell its latest batch of debt for an acceptable yield (10 year funding cost them 4.6%). There are good reasons to think that Spain is in a much stronger position:

Ireland's economy has shrunk more than any other in the EU economy during the crisis, shows no sign of recovering and the fiscal position of the government (excluding bank bail outs) is getting worse. Spain's economy has at least stabilised in 2010 and is at least not shrinking (Q3 GDP Spanish growth was 0%). The government's deficit as a % of GDP is narrowing to single figures and the government has set up major public spending cuts and tax rises to bring it down further.

Ireland was sunk by its banking sector more so than its public sector debt. In 2007 the Irish public sector deficit was the lowest in the EU at 25% of GDP and even with the crisis had only risen to just over 60% this year. However in 2010 the Irish deficit has ballooned to a remarkable 32% mainly as a result of the cost of bank bailouts, principally the AIB and the Bank of Ireland.

The markets just did not accept that the Irish could afford the guarantees given to these banks - the government had guaranteed 100% of their deposits and made some commitments to the bondholders of backing these bank. Ireland could not afford a bank bailout and get its deficit under control at the same time.

So, Spain in the clear? Not quite. There are some worrying similarities between Spain and Ireland's predicament:

- both economies are stagnating even before austerity cuts and tax rises have started to bite. Neither have the option of devaluing their currency to boost exports as they are stuck in the Euro.

- both not only had massive house price booms and bust they are both (unlike say the UK) still suffering the aftermath in terms of mountains of unsold properties dragging down prices

- Spain has its bank problems too. See Spain's economic crisis turns nasty

- Spain and Ireland have both lost control of their monetary policy so cannot engage in Quantitative Easing policies like the UK and US have done

- Spain is struggling to make its budget deficit-narrowing plans work (partly because tax revenues are stagnating and partly because the autonomous regions are not cutting spending to plan)

- if it were to suffer a double dip Spain would have nowhere to turn. In 2008/9 the government was able to spend its way to prevent the worst of the recession and even then it was pretty awful.

So if both economies are in the same predicament - deficits, austerity, stagnation, stuck in a Euro straitjacket - what sets Spain apart? The markets seems to accept that the scale of the Irish banks' problem set it apart. But I have my suspicions that Spain is more vulnerable than it appears on this front. The banks avoided much of the pain of the housing market crash by dodgy accounting and putting off foreclosures. They have in any case become the most reliant in Europe on borrowing cheaply from the European Central Bank. Another spiral down in house properties and an increase in repossessions - hardly outlying propositions - and the game could be up. Ireland today, Spain tomorrow? Watch the housing market.

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