Four events Spain doesn’t want to happen

November 23, 2010

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

LONDON — Spain is feeling the heat in the debt markets. Fears of contagion explain why it paid a much higher yield on short-term treasury bills than the same issue from last month. The country may avoid a debt crisis if it stays its course. But an unexpected event throwing doubt on the true state of the country’s finances could precipitate the mother of all bailouts. Here are four of the unpleasant surprises that could trigger a meltdown.

* A Spanish lender in dire straits. One of the most pressing problems for Spanish banks is access to long-term funding. Spanish lenders lend more than they gather in deposits, which makes them dependent on wholesale financing. True, banks and savings banks have sharply reduced dependence on the European Central Bank since the peak in July, thanks to improved access to the short-term repo market. But only the larger lenders have been able to borrow in the longer-term wholesale funding after the publication of the stress tests. A large number of the cajas, the savings banks, have been shut out, and the system as a whole faces massive refinancing needs in the next two years. Some institutions have already exhausted their allotment of state guarantees for senior debt. The brutal deposit war is a sign that Spanish banks are worried about their reliance on wholesale markets.

* A big region going bust. The state of Spanish regional and municipal finance remains a serious source of worry. Madrid, for example, is months behind on its bills, and the central government has so far rejected the mayor’s pleas for further debt funding. Catalonia recently issued a one-year bond to retail bank clients. Some economists believe regions could improve access to markets with more transparency. But an unexpected hole leading to a regional insolvency could trigger markets panic.

* Any whiff of wavering in the government’s commitment to structural reform: Spain found it hard to come up with a credible turnaround plan, including the beginning of structural reforms that might favour growth. Any hesitation, particularly on pensions financing, wouldn’t go down well with the markets.

* A severe economic slowdown. The government will have to make more budget adjustments next year if its optimistic growth assumptions fall short, as looks likely. But Spain couldn’t afford a serious slump, if the global economy were to stall, or if new unpleasant surprises were on the horizon.

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The really big worry is the 620bil euros owed to the Cajas by property developers. Are these loans being repaid ( given the 1 mil unsold properties ) and will they ever be repaid? As I understand it they are still on the books as performing loans – what happens when they are eventually written down?

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