In Europe: Spain’s Bailout Defeat Weakens Rajoy’s Deficit Goal

11 June 2012

Rajoy in a definite ‘damned if you do, damned if you don’t’ situation. Either way, Spain is set for a bailout!

Prime Minister Mariano Rajoy’s surrender to European officials on taking a bailout for Spain’s banks may weaken his political authority and his credibility in financial markets.

Rajoy’s June 9 request for as much as 100 billion euros ($126 billion) after stating two weeks ago that Spain wouldn’t need a rescue marks a swift reversal for the premier who won the biggest majority in 30 years in November. It may fuel skepticism he can meet his deficit-cutting promises.

“The emperor’s clothes are tattered,” Simon Maughan, financial strategist at Olivetree Securities Ltd., said in a telephone interview yesterday. “Unless he uses this money to attack the regions and control the failed cajas, what threads he has left will be stripped off him.”

Rajoy is trying to persuade regional leaders and voters to accept austerity, and convince bond investors the cuts will deliver the deficit goals he has pledged. Should he fail, he may have to return for a larger rescue for the Spanish sovereign, potentially draining the euro area’s financial ammunition.

Domestic Credibility

“Clearly his domestic credibility will have been hampered by this U-turn but at least he is partially recognizing the depth of the problem,” said Stuart Thomson, a fixed income fund manager at Ignis Asset Management in Glasgow, who predicts another bailout, this time for the government itself, within 18 months. “This bailout is predicated on a return to growth next year and we don’t think that’s possible.”

Spain’s benchmark stock index, the Ibex 35, jumped as much as 5.9 percent and traded 4 percent higher at 9:40 a.m. in Madrid. The extra yield investors demand to hold the government’s 10-year debt instead of German bunds fell to 466 basis points.

Part of Rajoy’s challenge is to bring regional governments in line after their mismanagement caused the country to miss its deficit-reduction targets last year. Regions also allowed the cajas, or savings banks, under their sway to run amok during the credit boom, leaving lenders loaded with real estate losses.

Rajoy’s fumbling of the Spanish banking crisis reinforced investors’ perceptions that European officials are still struggling to get a handle on the scale of the debt crisis almost three years after Greece confessed its budget deficit was higher than it had previously admitted. After a European summit in March, Rajoy announced that Spain would miss its deficit target. He hadn’t warned his counterparts.

No Clothes

“The entire euro zone political class has no clothes, though I’d hesitate to pick out Spain especially,” said Simon Johnson, former chief economist at the International Monetary Fund and now a professor at the Massachusetts Institute of Technology. He said Spain will probably need more than 100 billion euros to fix its banking system. “Spain’s handling of everything in the past two to three years has been very problematic,” he added.

Spain has made at least four attempts to clean up its banks since the collapse of the real estate boom in 2008, tightening provisioning rules, encouraging mergers and coaxing lenders onto the stock market. Bankia (BKIA), which was nationalized on May 9, was among lenders that sold shares to the public last year in response to government incentives. The IMF said the country’s “gradual approach” had allowed weak banks to undermine financial stability.

The Spanish economy fell into a second recession in three years in the final quarter of 2011. Fitch Ratings last week forecast the slump will carry through next year. The company cut the government’s credit rating to BBB, two levels from junk.

Market Access

While Rajoy has said since April that Spain risked losing access to capital markets, he continued to rule out the need for external help.

The premier said as recently as May 28 there would be no bailout for Spanish banks. Economy Minister Luis De Guindos said on May 11 that 15 billion euros would be more than enough to cover the needs arising from the second of two banking decrees he has drafted this year. Bankia Group undermined that forecast on May 25 by asking for 19 billion euros to absorb losses and bolster capital after its nationalization.

As the cost of rebuilding the banks mounted, foreign investors sold the government’s bonds on concern the state would struggle to fix the financial system without losing control of public borrowing. The extra yield investors seek to hold Spanish 10-year debt instead of German bunds reached a record 548 basis points on June 1, raising the pressure on Rajoy to change tack.

Semantic Discussion

“Their policy of dickering and delaying on giving out information piecemeal has contributed a lot to the problems which they are in,” said Thomas Mayer, an economic adviser to Deutsche Bank AG in Frankfurt.

Even yesterday, Rajoy refused to acknowledge that Spain had been rescued by the European Union, dismissing the issue as a “semantic discussion.” He said the bailout agreement was a sign of confidence in the Spanish government.

“Because we’d earned our credibility, the result of the euro group meeting last night became possible,” he said at a news conference in Madrid yesterday before flying to Poland to watch the national soccer team play in the Euro 2012 championship. “Now the situation has been resolved,” he added.

Under the terms of the June 9 deal, Spain will have access to up to 100 billion euros of financing from the EU that will be channeled to lenders through the government’s bank-rescue fund. European officials will set out how the rescued banks should restructure and the state will be on the hook for the full amount.

“Funny how to politicians words are more important than action,” said Steen Jakobsen, chief economist at Saxo Bank A/S in an e-mailed note. “A bailout is a bailout Spain, sorry.”


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