Spain's turmoil worsens as Europe awaits Greek fallout

Fri, Jun 15, 2012, 01:00

Markets will put leaders under huge strain as they deal with the Greek election fallout, writes ARTHUR BEESLEYin Berlin

SPANISH BORROWING costs surged to a new record yesterday, jeopardising the country’s bailout plan and escalating the debt crisis as Europe awaits the rerun of the Greek election with trepidation.

Euro zone finance ministers agreed less than a week ago to provide a €100 billion emergency loan to Spain’s stricken banks, but the arrangement assumed the country would remain in debt markets for day-to-day borrowing.

With the most basic details over the scale of support for individual banks still to be settled, senior European figures acknowledge deep flaws in the plan. Disruption on markets is set to place EU leaders under exceptional strain next week as they deal with the fallout from the Greek poll.

Although the Spanish government is perceived to be pursuing correct macroeconomic policies, the government and financial regulators have been under attack for underestimating the scale of the banks’ losses and for failing to concede earlier that external aid would be required.

Furthermore, at the highest levels the Spanish case is deemed to seriously undermine the credibility of previous EU stress tests which said it was essentially in good health. This, in turn, is feeding into the clamour for a much tougher system of pan-European banking regulation in a mooted “banking union”.

Spain’s borrowing costs have continued to climb in spite of the deal last Saturday, which Europe called a pre-emptive measure to calm market pressure.

The turmoil comes amid intensive debate over the prospect of Greece leaving the single currency if anti-bailout parties prevail in the election on Sunday.

The interest rate on Spanish 10-year bonds hit 7 per cent yesterday, a level considered “unsustainable” for a country with a large budget deficit and big borrowings to refinance. Italy too came under pressure yesterday, paying a steep interest rate to conduct a scheduled debt auction.

Any failure to quickly arrest the spike in Spanish bond yields could thrust the country towards a full-blown bailout, something that might stretch Europe’s bailout fund to the limit and increase market risks for Italy.

Economy minister Luis de Guindos insisted present rates could not be sustained indefinitely and suggested the government would take further action to tackle its finances. “It is not a situation that can be maintained over time . . . and I am convinced we will continue to take more measures in the coming days and weeks to help bring it down,” he said.

Madrid tried but failed to secure support for a direct-aid plan for the banks, without the money going onto its national debt. This was rejected by Germany, although it did win support from France, Italy, the International Monetary Fund and the European Commission.

Critics of the plan argue the addition of the bank debt burden to the Spanish state balance sheet was always going to make it more difficult for the country to retain the confidence of private investors.

In a further sign that the bailout has failed to win over doubters, Moody’s credit rating agency downgraded the standing of Spain’s debt on Wednesday night.

In Berlin, however, there is no change in the argument that any bid to mutualise bank debt would place an unacceptable burden on German taxpayers. Chancellor Angela Merkel reiterated her position yesterday, saying there would be no miracle solution.

As new data showed Greek unemployment hitting a record high of 22.6 per cent in the first three months of the year, Fitch warned of dire consequences in the country’s corporate sector if it leaves the euro.

“Current investors in euro zone debt have been approaching Fitch Ratings with queries on how Argentina’s 2001-2002 default and subsequent currency devaluation may shed light on some of the likely repercussions that would follow a Greek exit from the euro,” it said.

“The devaluation of the peso immediately increased Argentine corporate debt and put pressure on free cash flow generation, especially for smaller, domestically-focused companies.

“A similar situation could be expected in Greece; limited export ability, price controls, a potentially long recession and restricted local market refinancing options could all limit the ability of companies to meet interest and principal repayments.

“Greek companies could be even more exposed to a fall in trade because an exit from the euro would complicate broader relations with the EU free trade area.”