Minimal Spanish rescue could fail within weeks

ANALYSIS:EUROPEAN MINIMALISM was on display yet again this weekend. The world’s 12th biggest economy got a mini-bailout. Because the Spanish rescue package is so limited, it has the potential to fail within weeks.

But before considering the implications of the weekend’s developments for Spain and Europe, what does it mean for Ireland and the very vexed issue of debt taken on by the State to prop up the banking system?

Precisely nothing, is the short answer. The money to be lent to Spain will go straight on to the state’s balance sheet. There will be no Europeanisation of its bank debt. The belief that Spain’s crisis would be Ireland’s opportunity has been proved groundless.

If that is perfectly clear, the prospects of Spain’s mini-bailout working are much less so. Saturday’s package was designed to calm investor fears about its banks, thereby allowing the Spanish government to remain in the bond market so that it can fund itself in the normal way (the already bailed out trio of Ireland, Greece and Portugal remain shut out of the market and depend on handouts for all their spending needs).

The logic underpinning the Spanish rescue is that the markets are currently driven by irrational fear and that once this is quelled, all will be well. This could prove correct. When the €100 billion that Spain will have access to from Europe’s bailout funds is added to the approximately €750 billion its government already owes, it will still be less indebted than the euro zone average.

For the bloc as a whole, public debt stood at 87 per cent of gross domestic product (GDP) at the end of last year. In Spain, its ratio will go from just under 70 per cent of GDP to 80 per cent if all the €100 billion is used. That should be manageable.

It is in everyone’s interests that it proves to be so. Of the 17 countries in the euro zone, the Spanish economy is the fourth biggest after Germany, France and Italy. A full-scale bailout would drain the bloc’s rescue fund dry. If Saturday’s rescue fails, the euro zone will move yet another step closer to collapse.

The market reaction over the course of today will provide a good indication of what is in store for Spain and the euro. If yields (the effective interest rate) on Spanish government bonds do not fall significantly, the chances are that the country will, within weeks, be looking for multiples of the €100 billion it was pledged on Saturday.

While today marks the first hurdle for the Spanish rescue, next Monday could present a much bigger one. The Greek election on Sunday is a de facto referendum on remaining in the euro. If the Greeks fail to elect a government or vote into office an administration whose demands the rest of Europe will not accept, their ejection from the currency union will move centre stage. If the belief takes hold that any unravelling of the euro could take place, all the weaker countries will face increased pressure. That includes Spain, and Ireland too.

There are many other hurdles and pitfalls. Since the general financial crisis erupted four years ago, investors have feared not one but two unexploded fiscal bombs in Spain. The first, which has now gone off, was bigger bank losses. The second is bigger than admitted regional government debt.