Spain's Economic Woes

Moody’s Investor Service has recently downgraded the credit ratings of sixteen Spanish banks due to

a)      Recession in the country and weak economic forecast

b)      Increase in the number of loan defaults

c)      Reduced ability of the government to support debtors

d)      Little access to funding sources due to Eurozone debt crisis

Out of the sixteen, the outlook for ten banks remains negative while the remaining banks outlook will be under review. The banks that have been downgraded include two of the largest Spanish banks (Santander and BBVA). Banks that have been downgraded to ‘A3’ are

1.      Banco Santander SA (Santander’s UK based subsidiary Santander UK PLC has also been downgraded.)

2.      Banco Bilbao Vizcaya Argentaria (BBVA) SA.

3.      Banco Espanol de Credito

4.      Unicaja Banco SA

5.      Banco Popular Espanol

(Note: Santander UK is downgraded to A2. Spanish government’s rating is A3)

According to Moody’s official statement, "The Spanish economy has fallen back into recession in first-quarter 2012, and Moody's does not expect conditions to improve during 2012. Moreover, the real-estate crisis that began in 2008 is ongoing, and unemployment has risen to very high levels."

Unemployment

The reasons cited are neither exaggerated nor an overstatement. Spain has the highest unemployment rate of 24.1% in the entire 17 member Eurozone bloc, higher than Greece. Its future outlook is even worse as its employment rate is expected to touch 25% mark in 2013, which practically means that every 1 in 4^th person in the labour force will be unemployed. This also translates into decrease in income taxes and increase in unemployment benefits.

Interest Rates

As Spain’s economic condition worsens, the interest rates are increasing which makes borrowing more expensive. When Germans borrow money for 10 years, then they pay only 1.75% interest rate while Spain is offering about 6% on the 10 year note but still finding it difficult to get any funding.

Who is responsible?

In short, the general public and the government, both are responsible for the crisis.

When Euro was launched in Spain in 1999, the interest rates had fallen to record lows, borrowing had become extremely cheap. Naturally, the Spanish banks and financial institutions, property dealers and developers and the general public, everyone (except the government) went on a borrowing spree. Most economist agree that timely government intervention at that time could have prevented the current crisis. 

Once their liquidity was ballooned, they went on a shopping spree and invested billions in Spanish property. The increase in demand for property pushed up the prices. Although property prices were increasing in other European countries as well, (e.g. UK) but Spain’s price push was approximately three times more than UK’s.

Eventually the bubble burst and prices started falling. The construction industry was the first to fall with thousands of construction workers losing their jobs. Home owners who had taken out mortgage on their property were left perplexed --- the value of their property was falling --- interest rate wasn’t.

Surprisingly, it was like the beginning of 2008 global financial crisis all over again --- although this time the epicenter is Spain and it is not expected to go global, at least not in the near future. According to EU and IMF’s estimate, if Spain sticks to its plans and delivers on its promises then all of this should be over within the next three to five years.

Your comments and feedback are always appreciated.
Sarfaraz A.K.sarfaraz@when.com
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