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Monday, March 31, 2008

Spain Inflation March 2008

This is not good news at all. According to a flash estimate released by the Spanish national statistice office (INE) today (and confirmed on April 11, update. In addition the month-on-month inflation was estimated at 0.9% in the detailed release) the European Union standardised HICP annual inflation rate is expected to be 4.6% in March 2008. This flash reading provides a preview of the HICP that, if confirmed, would imply a two-tenths increase in the annual inflation rate in March, since in Febuary this change was 4.4%. The final reading will be published on 11 April. In the meantime what seems clear is that the Spanish economy is slowing rapidly even as inflation accelerates, and this will create a major headache for ratesetters over at the ECB, since with inflation accelerating in this way in several key eurozone countries (Italy is the other obvious case) it will be very hard indeed to justify any rate cut in the short term.





Update

Underlying inflation in Spain accelerated in March to the fastest pace in more than five years as processed food and clothing prices rose.

Core consumer prices, which exclude energy and fresh food, rose 3.4 percent from a year earlier after gaining 3.3 percent in February, the National Statistics Institute in Madrid said today in a statement. The rate was the highest since December 2002

Bread and dairy products were both 11 percent higher on the year and children's clothes were 4.6 percent higher than the previous month, the report said.

In further news at the end of the week the IMF have now forecast that the Spanish economy is likely to grow by 1.8 percent this year, half the 3.8 percent expansion of 2007. The jump in credit costs stemming from the U.S. housing crash is exacerbating Spain's own property slump and weighing on spending the IMF said.

Thursday, March 27, 2008

Spain Producer Prices February 2008

According to the INE data released earlier this week, producer prices in Spain were increasing at a year on year rate 6.6% in February, a very hefty clip, especially given the rate at which the economy seems to be decelerating.



The General Industrial Price Index registered an increase of 6.6% in February 2008 with respect to the previous year. The activities that most influenced this variation were Food and beverage products industry (11.0%) and Manufacture of coke and refined petroleum products (25.3%).

Spain New Morgtgages January 2008

According to the latest data from the Spanish Statistics Institute (INE), the average value of the mortgages signed in January decreased by a 1.9% year on year rate and reached 163,448 euros.

The value of mortgages creeated on urban buildings was over 21,357 million euros in January 2008, a year on year decrease of 25.7%. In the housing sector alone, capital loaned exceeded 13,395 million euros, 28.0% less than in January 2007.

There were a total of 138,527 new mortgages created in January 2007, a decrease of 23.59% year on year over January 2007.




On the other hand the number of morgages being modified for purposes of refinance jumped by 24.2 percent year on year.


98.3% of the mortgages created in January had a variable interest rate. Within the variable rate mortgages, Euribor was by far the most widely used reference interest
rate, being used in 87.6% of new contracts.

Wednesday, March 19, 2008

Spanish Bank Lending To Households January 2008

The lastest data on bank lending to households is now out for January 2008. Hardly surprisingly lending bounced back in January from December's virtual dead stop, and lending increased by and estimate 5,406 billion euro, up from a revised 553 million euros in December, but still well below the monthly average for 2005 and 2006 of around 9 billion euro.



This being said, the year on year rate of increase continues to move downwards steadily by the month.

Colonial Deal Off, SEOP Seeks Creditor Protection

Investment Corporation of Dubai (ICD) said today that it was not going to buy Spanish real estate firm Colonial after it failed to reach an agreement with the company's creditors. ICD did, however, leave the door open to future negotiations.

"If there was a possibility, beyond the conditions set on March 11, to reach an agreement with Colonial, ICD would consider such a possibility and would communicate it immediately," the fund said in a statement to Spain's stock market regulator.

But Colonial's shareholders, Luis Portillo and the Nozaleda family, also in a statement to the regulator, sounded a more pessimistic note. They said ICD had not reached a deal with the creditors "(and) no expectation exists that such an agreement will be reached." They added that they continue to search for a "satisfactory solution" for Colonial and its shareholders.

Meanwhile SEOP, Spain's 13th biggest construction firm, said yesterday that was seeking creditor protection due to the fact that its own clients - many of whom are property developers - had fallen behind on payments and bank financing was harder to come by.

Spanish property companies have piled up huge debts over the last decade in a bid to make the most of a real estate boom which was fuelled by a cocktail of low eurozone interest rates and high domestic economic growth. However, many property firms are now having to renegotiate loans they took out to buy land, build houses and buy rivals to diversify into other countries or areas of real estate.

Some, like Valencia-based Llanera have already gone bust while others like Habitat and Martinsa Fadesa have had to fight an uphill battle to try to restructure their debt. But the option of selling assets to pay debts is growing harder by the day as banks cut back on mortgages and potential buyers negotiate prices down as they start to feel that the selling party is coming under pressure.

SEOP had a turnover of 434 million euros ($686 million) and a net profit of 6.5 million in 2006. In taking this step it becomes the first major supplier to have been hit by the dwindling cash flow in the sector. The company did not disclose how much its debts amount to.


Non Performing Loan Ratios

Non-performing loans held by Spanish banks and savings banks rose by about 2 billion euros ($3.16 billion) in January from December to 16.23 billion, according to data published on Monday by the Bank of Spain.

The figure was 6.5 billion euros above the total in January 2007.

In January 2008, bad debts, including those held by credit cooperatives, represented 0.955 percent of loans worth a total of 1.7 trillion euros given to individuals and companies.

Bankers and regulators expect Spain's non-performing loan ratio to as much as triple from all-time lows this year as economic growth slows and unemployment rises.

A breakdown of January's figures showed that banks lent 770 billion euros with a bad debt percentage of 0.858 percent while savings banks have lent 838.5 billion euros with a non-performing loan level of 1.032 percent.

Last year, Spain's biggest bank said its bad loan rate rose to 0.95 percent from 0.82 percent in 2006 while its leading savings bank La Caixa had a non-performing loan rate of 0.55 percent, up from 0.33 percent a year earlier.

The Bank of Spain said cooperative banks had credits of 91.5 billion euros and bad debts totalling 972 million.

Consumer credit agencies have issued loans to the tune of 58.5 billion euros by the end of January with a bad debt level of 3.1 percent.

Spain's bank and savings bank bad loan ratios are coming into line with other big European economies like Britain where the number of mortgages three or more months in arrears was 1.1 percent in 2007, according to the Council of Mortgage Lenders.

However, it is still well below countries like Greece where the central bank has said it will ask banks to bring down their non-performing loan ratio to 3.5 percent from 5.4 percent in 2006.


Update Wednesday 26 March 2008

Real estate company Cosmani joined the growing list of Spanish property firms filing for administration today. In a statement on today, Cosmani said five of its 22 units filed for creditor protection last week, around the same time as construction company SEOP had to go into adminstration because clients were not paying their bills. Cosmani's own statement is not without some significance:

"Cosmani's solvency is not in doubt as its asset value is much more than its total debt, but business has suffered because of adverse conditions in the property and financial sectors that have caused a temporary liqudity shortage,"


The group claim banks were trying to call back loans and bank guarantees, some of them ahead of maturity. Cosmani said it had 350 million euros ($545 million) of debt, almost all of it with banks, while its assets were valued at 1.6 billion euros. Net equity was 74 million euros.

Sector specialists are quoted in the press as saying they expect several property companies to file for protection under a new Spanish insolvency law which allows firms to draw up a "viability plan" including asset sales and debt renegotiations rather than going bust, which hurts banks more than agreeing to wait for repayment. Effectively Spanish property companies are are being squeezed on both sides at the moment with sales drying up while banks are trying to cut their risk exposure to the property sector, particularly in the wake of the U.S. subprime crisis.

A significant list of other property companies - from unlisted Habitat to blue-chip Colonial - are locked in talks with their banks to restructure billions of euros of debt they piled up to buy land and rivals during the decade-long housing boom. Martinsa-Fadesa is having to renegotiate its 5.1 billion euros debt while unlisted Detinsa is also trying to sell assets and change its debt structure to avoid insolvency.

Martinsa Fadesa said earlier today it expected to get approval later this week from all lenders on renegotiating terms of its 5.1 billion euro ($8 billion) debt load.
Martinsa, which is already in default, wants lenders to agree to defer debt and interest payments. It said in a statement to the Spanish stock market regulator that missed payments could be folded into a new agreement.


Martinsa has been struggling with its creditor banks, hedge funds and other holders of its debt in an attempt to reach a restructuring agreement. Debt agreements need to be signed by all creditors.

The new agreement is likely to cover only a part of the 5.1 billion euros debt pile, not its entirety as the company had originally hoped, according to widely quoted sources. Martinsa failed to make an interest payment this month and did not win a waiver that would have extended an interest payment of 362 million euros, due on March 17. Talks to reach a deal to save the firm from insolvency remain "very difficult," a banking source close to the talks was quoted as saying earlier today.

The negotiations, initially set to be finalised today, will be extended over the next few days. Ahorro Corporacion Financiera, La Caixa, Caja Madrid and Morgan Stanley are lead arrangers of the company's 5.1 billion euro loan, and hold more than half of it. Other debtholders include hedge funds and Collateralised Loan Obligations (CLOs) that control "less than 10 percent" of the debt.


Interestingly, at just about the same time as all this was taking place in Spain, Spanish developer Martinsa Fadesa was busy starting the construction of its first major project in Bulgaria, Stroitelstvo Gradut (Construction and the City) weekly reported. The "first-sod" ceremony of the Modera Residence residential complex took place on March 18.

The complex is located in Sofia’s Vitosha neighbourhood, at about 200 m from the ring road and Simeonovsko Chaussee Blvd, and will have a gross actual area of about 54 000 sq m. Architectural project was prepared by Stroyconsult 999 Ltd, with leading designer Yuri Angelov; general contractors are Livel and Hydrostroy-P; the consultant is Nevon Consult Ltd. The neighbourhood has been one of the most actively constructed areas in recent years. Another two new gated communities, Preslav and Buena Vista, are located in the vicinity.


Now why the above is to some extent worthy of mention is that it highlights the extent to which enbattled Spanish property companies have been trying to save their situation by turning east, but it is not clear at this point whether this will improve or simply aggravate their situation, as the construction sectors in some of the more seriiously "overheated" east european economies - like Bulgaria and Romania may well themselves experience and important property "correction" some time in 2008.

Sunday, March 16, 2008

Spain's Looming Economic and Financial Crisis

My co-blogger on Global Economy Matters Manuel Alvarez in his post on last weekend's Spanish election called it "Zapatero's election to lose", meaning by this that the opposition scarcely seemed credibly poised to win, and their best chance of victory rested on the possibility that Spain's Prime Minister Jose Luis Rodriguez Zapatero might somehow or other manage to clutch defeat straight out of the jaws of victory (aka throw the election away). In the event he didn't, and the Partido Popular now face another 4 years sitting it out on the opposition benches.

But there is another sense in which one might think that this was Zapatero's election to lose, and that is connected with the scale and importance of the economic problems which are steadily arriving on the Spanish centre stage, since I sometimes find it hard to understand how anyone would actually be able to relish winning having won this one. I think it really is true that there are occasions when discretion is the better part of valour. Wolfgang Munchau effectively made a similar point in a recent Financial Times Op-ed where he suggested the the winner, whoever he should was destined to " spend the next four years cleaning up an economic mess on a scale not witnessed in Spain in modern times".

I thoroughly agree. I also agree that Munchau more or less hits the proverbial nail directly on the head when he goes on to suggests in his article that "the twin engines of the coming Spanish economic crisis are a collapsing housing market and a current account deficit, now at 10 per cent of gross domestic product". As he also points out, these two are related since it has been the inflow of investment which has funded the lending associated with the property boom which has enabled Spain to finance its current account deficit. But now that this flow of funds has all but come to a halt, as has the lending which went with it. During the years between 2004 and 2006 Spanish househoolds were increasing their borrowing at a rate of about 10 Billion euros a month. In November 2007 they increased their borrowing by 12.5 billion euros, and in December 2007 it went up by a measly 500 million euros (to see what happened to new bank credit last December see this chart, or the "raw data" in this pdf). This is what is known in the economics trade as a "sudden stop", and is undoubtedly due to the funding crisis which the Spanish banks are currently suffering (see below, but basically if you have no new money then you can't make new loans). The Spanish banks have plenty of mortgages on the books, but what they don't have is a lot of money, which is basically why they now need to queue up at the weekly ECB auctions to trade pieces of mortgage backed paper (otherwise known as cedulas) for cash. However, as many commentators are already noting, this kind of situation was never anticipated when the banking eurosystem which lies behind the paper money we have in our hands was first devised and created. However without a longer term solution to the problem it is by no means clear where the Spanish banks are going to get the money they need to lend to their customers (or indeed now that the housing boom is well and truly over what the money would be borrowed for) or, if they don't attract external funding they need to square the books, how Spain's extraordinarly large external deficit is going to be financed.


Financial AND Economic Crisis


Perhaps the first thing to get absolutely clear in our minds from the outset is that the economic correction which is currently taking place in Spain is very unusual one in terms of what we have become accustomed to in developed economies in modern times, since the transmission mechanism for Spain's current difficulties does not run in simple one-way-street fashion from problems which have their source in the real economy (a correction in house prices for example, or a downsizeing of the construction industry, although both of these undoubtedly form part of the picture), nor does it run from an attempt by a central bank to "burst" some sort of perceived asset bubble or other (Trichet and the ECB's tightening of interest rates), rather the mechanism operates via a direct blow-out in the cylinder-head-gasket of the global financial system, a blow-out which has produced an immediate and direct change in global credit and lending conditions, and in the level of risk appetite which prevails in the securitised mortgages/covered bonds sector of the wholesale money markets (leading to a situation where these markets are now effectively closed to Spanish banks) , and it is this change in financial and credit conditions which is now making its impact felt on the real economy in Spain, with the actual and present danger that these negative consequences for the real economy may then in their turn feed back into the financial sector, in the process creating some kind of ongoing lose-lose dynamic.

As I say, such a phenomenon is certainly unusual in a modern European context, although some may wish to point to parallels with what happened in Japan in the early 1990s, and the subsequent "lost decade". I wouldn't go so far at this point as to suggest that Spain is facing a lost decade, although the situation is very very serious (as I hope to show in the charts that follow), and at the very least Spain now faces several "lost years" and a massive macroeconomic structural adjustment.


A Slowing Real Economy

So first of all lets have a brief look at some of the factors which may give us an idea of just what has been happening to the Spanish "real economy" in the last months.


Unemployment is up, and substantially so. Unemployment in Spain has now risen from something over 1.9 million in June 2007 to something over 2.5 million in February 2008. The figures were up year on year by some 9.9% in February.

Regional differences area also imortant, with the year on year rises being very strong in some costal areas, like Valencia (20%) and Murcia (30%). As we can see from the comparative chart, the labour market moved in a positive direction from January 2006 to May 2007, then it turned in June 2007, since which point what we have had has been essentially a one way street of pretty bad news.


Strangely, while the economy has been slowing and unemployment rising, prices have continued to rise, and inflation has accelerated with the latest flash estimate for CPI inflation in February issued by INE, the Spanish Statistics Office, coming in last week at 4.4% for the second month running.

In this context of rising prices and unemployment it is hardly surprising that consumer confidence is taking a big hit, and if we look at the confidence index, we will find that despite registering some very slight improvement for the first time since April last month the general index, which stood at 76.8 in February was still very near to plumming all time historic lows (see chart here)

The European Commission have also recently reported a continuing decline in its eurozone “economic sentiment” indicator in February, with the composite number for the whole zone reaching its lowest level since December 2005. The indicator, which gauges optimism across all economic sectors and is regarded as a reasonable guide to likely future trends, fell to 100.1 points in February from 101.7 in January.

While the picture across the eurozone shows considerable variation at this point with France holding up better than most, and Germany (as explained here) is hanging on in better than I personally expected, but Italy is very much in the doldrums already, and the two "construction driven" eurozone economies (Spain and Ireland) are - as can be seen in the chart here - now in strong downward retreat.


But it is when we come to the real data that things start to get decidedly hairy. Eurostat have, for example, just published the January retail sales data, and the Spanish numbers do not look good at all. Basically retail sales have now contracted in 5 of the last six months. In January they were down 1.1% on December (seasonally adjusted of course) and 2.4% on January 2007. If you look at the chart there is now a very strong clear downward trend (which resembles more what we have been seeing in Latvia or Hungary in recent months than the kind of data product we are accustomed to getting from Western Europe), and the only real question is where this will now stop. The slide is evident. Basically this is a reflection of construction and banking sector issues gradually arriving and making their presence felt on the real economy.


Spanish manufacturing activity contracted again in February, posting its weakest performance in over six years, according to last Monday's NTC Purchasing Managers Index (PMI). All five component indices of Index (PMI) pointed to worsening conditions as both production and new orders fell in February following the modest growth reported in January.

The headline PMI, which measures the general health of Spanish manufacturing, fell to 46.7 -- its lowest since December 2001 -- from 49.8 in January, pushing it further below the 50.0 mark separating growth from contraction.



The data from the manufacturing PMI is pretty consistent with the latest industrial production data released by the Spanish Statistics OFfice (INE). Accoring to the release the Spanish Industrial Production Index - when adjusted for working day effects increased by 0.7% in January when compared with January 2007. Uncorrected the Index was down 0.2% year on year.



Activity in Spain's service sector also fell to a record low in February as costs surged while business gave few signs of any kind of bounce back, according to the NTC Purchasing Managers Services Index (PMI) published las Wednesday. Though the headline PMI figure recovered to 46.1 from January's 44.2 (see the chart above), the figure was still well below the 50 mark which divides growth from contraction and was the second weakest reading in the survey's 8-1/2 year history.


And Then There Is Construction

I take it that it goes without saying that one part of this problem is now deeply ingrained in the contstruction sector, and even if in this post I want to concentrate attention in two of the more neglected areas of Spain's current embarassment - the real economy and the financial sector - I obviously can't let all this pass by without some mention of what is happening in construction. One small data point here really says it all, and that is the estimate from the IPE business school that in March there some 500,000 unsold new homes in Spain - more or less the equivalent of one year's residential construction output at the old pace. And of course the old pace is now history. Spain's economy is not going to be able to get the old uplift by producing anything like 500,000 new housing units a year anytime in the foreseeable future.

We could also look at the December mortgages data, which, as was to be expected, saw a decline in both the value and the number of new mortgages (and it should be remembered that mortgages and construction were still being driven to some extent by the competion of old orders, ie those that predated the advent of the credit crunch in August 2007). The average value of the new mortgages created in December was 161,142 euros - down 1.9% on December 2006, although this number was in fact up 1.4% on November 2007. Perhaps more significantly the number of new mortgages (102,976) was down in December by 26.87% on November and 14.6% on December 2006. As a result of the reduced numbers of properties being newly mortgaged the total value of mortgage loans (16.59 billion euros) was down in December by 25.88% on November and 16.24% on December 2006.


We could also try looking at what Wolfgang Munchau calls his favourite current chart (although why anyone would call such an appaulingly depressing picture a favourite is beyond me) - the one originating with Bank of Spain data which shows how building approvals and permits have (and I quote Munchau) "fallen off the edge of a cliff since the end of 2006".


As Munchau points out, at their peak in March 2007, house building permits were rising at an annual growth rate of 25 per cent. In the autumn of 2007, their annual change had dropped into the region of minus 20 per cent. The situation in terms of approved starts is even more dramatic, since these rose at an annual growth rate of close to 28 per cent in March 2007. By September the annual rate of change had fallen to minus 66 per cent. House prices have not fallen significantly in Spain yet, but this is surely only a matter of time, and especially when we come think about the large stock of unsold new homes (estimated as I say at 500,000 as of March 2008) waiting on the books, and the drop in the number of mortgage loans mentioned earlier in this post.

Systemic Financial Crisis?

So now for the cherry which is currently perched smartly on the top of our Spanish election Sunday pudding: the problem of how to provide suffient liquidity to the banking system to square off the monthly balance of payments deficit. Now Wolfgang Munchau correctly ties-in the capital inflows which have been needed to finance the Spanish housing boom with the huge balance of payments surplus Spain currently runs (Spain needs in the region of 9 billion euros in external finance a month to keep this afloat), but I'm not sure he has yet fully appreciated just what a problem for the Spanish banking sector - and indeed for the whole eurosystem - this financing problem can become, since while he correctly points out that in the Spanish case "there can be no currency crisis....since Spain does not have its own currency", he omits to ask himself the equally pertinet question as to whether or not there could be a (euro-) systemic banking crisis? As I try to argue in some depth in this post the answer to that question is that there most certainly can.

Perhaps another data point would be useful here. The Spanish banks currently attend the weekly liquidity auctions at the ECB to raise something in the region of 48 billion euros of funding (a figure which is double the 24 billion euro number they needed before the summer). However, as Jean Claude Trichet insistently points out, "there is no question that the Spanish - or any other - banks are being bailed out" at this point. This, like so many of Trichet's statements is entirely true. But it is not the whole truth. That is, there is a bigger picture. And herein lies the problem.

It is, for example, also true that the ECB has not changed its rules to accept mortgage backed securities (like the US Fed had to under pressure last August), but this apparent constancy in rules also stands alongside the fact that a banking system which didn't need much recourse to the facility in question has now doubled its use of it, and in a very short space of time.

It is also true that Spanish banks were not allowed by the Bank of Spain to set up special purpose vehicles to finance their lending, but again, they set up the cedulas hipotecarias to find another way to do something which, at the end of the day, is not that disimmilar. The argument against SIVs is that off balance sheet lending is likely to be more risky, but in a certain sense (and as I try to argue and explain in my post here on the cedulas system) the cajas regionales have played the role of off balance sheet entities for the principal banks, and since we still don't know how far down the value of the entire Spanish mortgage pool is going to fall, we have no way at this point of making a valid assessment of the level of risk that has been actually taken on board.

It is also the case that the level of mortgage defaults in Spain is at this point comparatively small, but then again the whole process is only just starting, so it is far to early to say at this point whether or not cover will prove adequate in the longer term, but then again, the problem for the Spanish banking system may not originate in defaults in the first place, but rather from a perceived rise in their risk rating if the value of the entire pool of mortgages on their books starts to decline significantly.

So Where Is The Problem?

Well if we want to get a first measure of what kinds of problem are looming in the Spanish banking system we could think about the level of incoming bond purchasing Spain has benefited from in recent years (and we can get reasonably accurate data on all of this thanks to the monthly balance of payments data made available by the Bank of Spain). The Spanish bonds boom really took off sometime in 2002, and it came to a sharp and rather unfortunate end in the middle of 2007 (I would say on or around the 9 August). In any event the height of the boom was in 2005, 2006 and the first half of 2007.

The take off date for the Spanish bonds boom is hardly accidental, since it more or less coincides with the arrival over a sustained period of time of negative interest rates in Spain (since with the ECB refi rate at 2% and Spanish inflation in the 4% range, interest rates were running around the minus 2% level, a rate at which it would almost seem foolish not to borrow money and invest in a housing or flat whose price it seemed would never stop rising). So this one simple fact explains to a considerable extent the intensity of the Spanish housing boom.

But since the "financial turoil" started in August last year, demand for Spanish mortgage-backed bonds (the so called cedulas) has all but dried up. Recent months are not the first time that the cpaital inflows to Spain have "wobbled", but this time the wobble is much more sustained and, since the wholesale money markets are at this point effectively closed to the Spanish banks, there are good reasons for imagining that this time the change will be a more permanent one.


Now, why, apart from the implications for the banking system, is all this so important for Spain? Well lets think about another part of the problem, the current account deficit one. The fact of the matter is the sutained consumer boom which developed in association with the construction one had a long term and pretty disastrous impact on Spain's external trade balance (and in particular on its energy component, all those extra houses use energy remember). And this deterioration in the external trade position has remained, and arguably gotten slightly worse, even as the economy has started to slow down.

In the past, as I have been saying, this deficit has been offset by the sum total balance of funds coming in as part of the financial account, but this is precisely what has dropped off since August last year.


The consequence of this is that Spain's banks are increasingly having to find the money they need to make the books balance via the eurosystem, and this is basically the significance of that increase in borrowing that the Spanish banks have had to undertake at the weekly ECB auctions (referred to in this post ). The evolution of the net asset and liability position of the Spanish banks vis-a-vis the eurosystem has been totally transformed in recent months, and the underlying position has moved from one where the movement in Spanish bank liabilities showed no particular trend to one where there is now a large and constant increase in the amount of money borrowed every week by the Spanish banks from the eurosystem (presumeably largely or exclusively at the ECB auctions), and this money is essentially needed to settle the monthly deficit in the balance of payments account.

As I say, prior to August 2007 the movements in asssets and liabilities showed no particular trend, but since August, and for every month for which we currently have data, the Spanish banks have needed to raise additional money at the ECB. This is really a direct result of the fact that the banks have been unable to sell their cedulas for cash in the global markets. What the Spanish banking system lacks right now is a way to generate cash on a stable basis to meet the needs of the current account deficit.

Now as I have been regularly pointing out, another of the very specific features defining the way in which the property boom was financed in Spain lay in the ability of the Spanish banking system to provide very low interest (variable) rate mortgages. Curiously, many commentators imagined that this (variable) component constituted the greatest risk element in Spain. That is, they imagined that it was Spain's mortgage borrowers (or homeowners) who were assuming the greater part of the risk, and that the risk lay in the danger of ECB base rate increases of the kind we had been seeing before last August. As it turns out they were wrong. Risk at present has almost all been inadvertently assumed by Spain's banking system, and this decidedly odd situation has arisen (I'm sure this was never the intention) due to the recourse of Spain's banks to the widespreased use of securitised (or covered) bonds - the so called cedulas - and the provision of variable mortgages at very narrow margins (lets say around 0.75% or 1% over 1 year euribor). Now the banking system considered it was onto a sound bet here, since the banks in their turn could borrow (thanks to the investment AAA grade often assigned to these bonds, which made them virtually equivalent to government paper) at very favourable rates themselves (normally three month euribor). This they felt meant they were treading on very solid ground. Again they were wrong, since it is just this very global repricing of risk appetite I mentioned earlier, and the reassessment of the AAA rating which was previously assigned to their mortgage bonds which goes with it, which has produced the problem.

Oh, yes, and there's a third little detail which makes all of this just that little bit worse. The different term structures of the lending and the borrowing. Basically the Spanish banks, and especially in the current context the regional cajas (since these cajas have undoubtedly been landed with the lions share of the problem), borrowed short and lent long. The majority of the mortgages issued between 2000 and 2007 had a duration of between 20 and 30 years. Indeed during the last two years of the boom it even became fashionable to offer mortgages over 50 years, so sure did the banks feel of themselves.

But they borrowed short. Not the very-short-liquidity type borrowing that we are increasingly seeing Spanish banks having to resort to as they stand in line at the ECBs weekly money auctions of course, but rather the lions share of the borrowing, which was done using cedulas, and normally over a ten year term or even less. That is to say, while the vast majority of the mortgages issued will still be outsanding come 2025, almost all of the bonds which go with them will need to be refinanced, and in particular during the years between 2012 and 2017. And here is where we hit the snag, since the money markets which the Spanish banks need to do the refinancing are currently closed to them. These money markets can of course be reopened, but at a price (ie the price of a risk premium), and that is really the bigger half of the snag, since while the debtors are on "variable" mortgages , these are effectively fixed (at 1 year euribor plus something, euribor can of course go up, but it can also go down, as I think we are about to see in the next moves at the ECB). So the borrowers, it turns out, really do have a yardstick that lets them know what they are into. This is not the case with the lenders (the banks) however, since while we do not know what eventual risk premium will be built in to fund Spanish banks (this in part depends on how far and how fast property prices fall, and how much difficulty the banks have in maintaining their mortgage pools), we do know that the days when they could fund them at a simple euribor 3 month rate (y punto) are now well and truly over, and we could even contemplate the possibility that if bad goes to worse, and even worse, and then worse again, then they could be asked to pay even more than they are recieving from their mortgage paying clients!

And the amounts of money are not small. One good recent estimate put the total quantity the banks will need to "roll over" in the space of about 5-7 years at some 300 thousand million euros.

A country with a large and sustained current account deficit - as we can see in the case of the United States - can do one of two things. It can tighten money and credit conditions in order to try and use an indirect method to slow internal demand, or it can allow the value of the currency to slide (as we have seen and continue to see in the case of the dollar) in a direct attempt to reduce the deficit. But, as Munchau pointed out, Spain has no autoctonous currency of its own to let slide, so the only real alternative is to squeeze internal lending to try and reduce the deficit, and in the meantime lean on the ECB for money. The contraction in lending needed to reduce a deficit of this magnitude is most probably going to be very large indeed, and the consequences for the real economy may well be substantial, so it is to be anticipated that in the short term some other makeshift alternatives will be sought. What these alternatives might be are currently a complete mystery, since for reasonably obvious reasons little of the discussion which must currently be taking place behind the curtains has found a public airing at this point, even though we in Spain have been living though what was otherwise a heated electoral debate. All we can do is watch, stupefied, and wait, as the organisers of the concert prepare to emerge from their cabal to let the public in general know what gets to happen next.

So as Spaniards survey the outcome of last weekends polls they might like to reflect on this thought. Given what we have seen in the course of this post, Spain would appear to be currently running the risk of being the first modern developed economy to suffer the twin issue of a sudden-stop in the credit system and a dramatic slowdown in the real economy at one and the same time, yet in the seemingly interminable election debates which have taken place over the last month or so this singular and intriguing little detail has scarcely been mentioned. Of course there has been plenty of talk of the "construction slowdown", and plenty of finger pointing about who exactly is responsible for it, but the full measure and extent of the problem has been scarcely aluded to, even in the faintest whisper. Yet one of these days in the not too distant future someone is going to have to emerge from behind the curtains to let the rest of us all know just what the plan actually is.

Sunday, March 09, 2008

Spain January 2008 Industrial Output, February Manufacturing and Services PMI

Spanish manufacturing activity contracted again in February, posting its weakest performance in over six years, according to last Monday's NTC Purchasing Managers Index (PMI). All five component indices of Index (PMI) pointed to worsening conditions as both production and new orders fell in February following the modest growth reported in January.

The headline PMI, which measures the general health of Spanish manufacturing, fell to 46.7 -- its lowest since December 2001 -- from 49.8 in January, pushing it further below the 50.0 mark separating growth from contraction. General Industrial production fell for the first time in five years, putting on its worst performance in over six years, with anecdotal evidence suggesting falling new order volumes had led firms to cut output. Manufacturers' new order volumes fell at the sharpest pace for 74 months in February (since December 2001), with the reduction in new work linked to worsening domestic demand alongside greater competition from abroad. The survey also suggested that alongside the ongoing internal demand contraction which Spain is undergoing, the continuing strength of the euro against the dollar is contributing to weaker export demand. The forward-looking indicators in the survey continued in the same gloomy vein, with employment expectations falling for a sixth consecutive month, while purchasing plans fell at the sharpest pace since July 2003. Outstanding work work awaiting completion also contracted.




The final RBS/NTC Eurozone Manufacturing PMI - Purchasing Managers' Index - (a composite indicator designed to provide a single-figure summary of business conditions) registered 52.3 in February. The PMI was in line with the flash reading and down from 52.8 in January, signalling a slight weakening in the rate of expansion to the second weakest level registered in the past two-and-a-half years. PMI readings among the big-four euro nations showed the widest variation for seven-and-a-half years, with continued solid growth in Germany and, to a lesser extent, France contrasting with near-stagnation in Italy and an accelerating rate of contraction in Spain. The PMI for Italy hit a two-and-a-half year low while Spain saw the sharpest rate of contraction since December 2001.

Of the big-four countries, only Germany saw an acceleration in output growth. A modest easing in the growth rate in France meant the two biggest Eurozone economies had identical rates of increase. In contrast, output growth fell slightly in Italy to a rather modest pace, while production in Spain, as we have seen, fell for the first time for five years, and at the steepest rate since December 2001.

The data from the manufacturing PMI is pretty consistent with the latest industrial production data released by the Spanish Statistics OFfice (INE). Accoring to the release the Spanish Industrial Production Index - when adjusted for working day effects increased by 0.7% in January when compared with January 2007. Uncorrected the Index was down 0.2% year on year.






The calendar adjusted year on year rates of change were 1.8% for consumer goods (-1.1% for durable consumer goods and 2.3% for non-durable consumer goods), 4.6% for capital goods, -2.3% for intermediate goods and 1.6% for energy. The activities which saw the greatest increases in January were the manufacture of radio, television and communications equipment and apparatus, and the manufacture of tobacco products, which jointly rose by 10.5%. In contrast, the strongest contraction was in the manufacture of office machinery and computers, at -24.6%, and mining and quarrying of energy producing materials, at -19.2%.



Services PMI

Activity in Spain's service sector also fell to a record low in February as costs surged while business gave few signs of any kind of bounce back, according to the NTC Purchasing Managers Services Index (PMI) published las Wednesday. Though the headline PMI figure recovered to 46.1 from January's 44.2 (see the chart above), the figure was still well below the 50 mark which divides growth from contraction and was the second weakest reading in the survey's 8-1/2 year history.


"Clearly there's a lot of downward pressure on growth," Chris Williamson, Chief Economist at NTC Research is quoted as saying. He added that the survey's forward-looking indicators emphasised the risks of a sharp slowdown in Spain after a long economic boom. A measure of confidence in the business outlook slipped to 59.2 from 59.8 in January (achieving in the process a fall of 14.2 points in a year and a new low for the survey) with respondents stressing their apprehension in the face of increasing economic uncertainty.

The new business index recovered somewhat to 45.9 from 43.5 but showed demand still falling. As firms continued to work their way through backlogs of business, employment showed the most marginal growth in 4-1/2 years.

Thursday, March 06, 2008

Spain Retail Sales January 2008

Well Eurostat have just published the January retail sales data, and the Spanish numbers do not look good at all. Basically retail sales have now contracted in 5 of the last six months. In January they were down 1.1% on December (seasonally adjusted of course) and 2.4% on January 2007. If you look at the chart there is now a very clear downward line, and the only real question is where this will now stop. The slide is evident. Basically this is a reflection of construction and banking sector issues gradually arriving and making their presence felt on the real economy.


Spain Unemployment and Consumer Confidence February 2008

We now have the February unemployment figures from INEM and the February Consumer Confidence reading from the Instituto de Crédito Oficial.

On the unemployment front, the numbers are obviously up, and in some cases substantially so. Unemployment in Spain has now risen from something over 1.9 million in June 2007 to something over 2.5 million in February 2008. The figures were up year on year by some 9.9% in February.



The regional differences area also imortant, with the year on year rises being very strong in some costal areas, like Valencia (20%) and Murcia (30%). As we can see from the comparative chart, the labour market was moving in a basically positive direction from January 2006 to May 2007, then it turned in June 2007, since which point it has been essentially a one way street of pretty bad news.



If we turn now to the consumer confidence index, we find that this has registered a slight improvement for the first time since April on the general index, which was up at 76.8 from 70.9 in January.



What we should bear in mind here are two things. In the first place we are still at very low levels, and secondly Spain doesn't *feel* like it is in any sort of serious crisis at this point in time. Of course people are aware that this is not a particularly good moment, and that the construction industry is having a bad time of it, as reflected in the employment figures. People are also aware of an inflation problem. But beyond that most people cannot conceive of what might actually be happening behind the curtains. It is election time, but what has been most notable - apart from the evident and predictable party bickering - is that the politicians have been by and large at great pains to reassure people. Of course party "x" does things very badly, and party "y" would do things much better. But no one is suggesting that under the bonnet of the car the engine might be badly broken.

In part this is because - since this is more than anything a structural crisis of the eurosystem - it is hard to attribute blame to the other, but it is also due to the fact that noone, but noone, wants to alarm people unnecessarily. Apart from the construction slowdown the problem is mainly in the financial system at this moment in time, and since an effective temporary torniquet is being applied by the weekly visit to the auctions at the ECB, blood is not visible all over the floor at this point in time. And since noone really knows what the "solution" to all of this is at this point, then disretion is the better part of valour, and better to keep mum till we do know what we want to do. Then in time honoured fashion someone will step forward from behind the curtain and announce to the stupefied spectators that a plan of action has been decided on, but that there will be no refund in the entrance price to compensate for the inconvenience. Of course this makes something of a farce out of the present elections. But quite honestly I don't see what else they could do, since little that is useful would be achieved by simply putting the fear of god into everyone.

So, and to wind this up, we could take a look at the subcomponents chart for the confidence index, where we will find that there of them turned up, and especially the expectations one given all the reassurance that people are being given, but that one - the employment outlook component - continued to move down, which is just about right if we go back to the employment data with which I started this post.

Monday, March 03, 2008

EU Economic Sentiment Indicator, New Mortgages, Inflation etc

Quite a bit of Spain related data has come out over the last few days, including the latest flash estimate for CPI inflation from the INE, which came in at 4.4% for the second month running.



Given that most of the Spanish economy is slowing rapidly this sort of inflation is likely to prove itself to be a real headache, especially over at the ECB. The problem is only added to by the latest reading on the producer price index which was up 6.6% year on year in January, indicating that there is still a lot of inflation momentum in the system.




The European Commission also reported at the end of last week a further steep decline in its eurozone “economic sentiment” indicator for February, with the composite number reaching its lowest level since December 2005. The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, fell to 100.1 points in February from 101.7 in January.

This seems to imply a significant deceleration in activity, although the picture is very variable. France is holding up better than most, and Germany (as explained here) is hanging on in more than I personally expected, but Italy is very much in the doldrums already, and the two "construction driven" eurozone economies (Spain and Ireland) are in strong downward retreat.




The countrywide fall was led by the service sector but the index for Spain, were the impact of a bursting property bubble is in the forefront of everyone's mind, was especially pronounced. With a reading of 87.5 the indicator hit its lowest level since January 1994. Italy’s index also dropped steeply, to the lowest level since August 2005.

One measure of the slowdown in activity is the rate of expansion in industrial output, which has proved rather volatile, but the rate slowed notably during the year, with the year on year changes being neagtive in both November and December.



We also now have the December mortgages data, and as was to be expected, both the value and the number of new mortgages was down. The average value of the new mortgages created in December was 161,142 euros and this was down by 1.9% on December 2006, although it was 1.4% higher than the equivalent number for November 2007. For housing mortgages alone the average amount was 143,739 euros, 0.2% more than in December 2006, and 2.2% less than in November. Even more significantly the number of new mortgages in December (102,976) was down 26.87% on November and 14.6% on December 2006. As a result of the reduced numbers of properties being newly mortgaged the total value of mortgage loans (16.59 billion euros) was
down 25.88% on November and 16.24% on December 2006.




Finally we have what Wolfgang Munchau calls in his weekend op-ed in the Financial Times his favourite current chart (although why anyone would call such an appaulingly depressing picture a favourite is beyond me) - the one from the Bank of Spain which shows how building approvals and permits have (and I quote him) "fallen off the edge of a cliff since the end of 2006".




As Munchau points out, at their peak in March 2007, house building permits were rising at an annual growth rate of 25 per cent. In the autumn of 2007, their annual change had dropped into the region of minus 20 per cent. The situation in terms of approved starts is even more dramatic, since these rose at an annual growth rate of close to 28 per cent in March 2007. By September the annual rate of change had fallen to minus 66 per cent. House prices have not fallen significantly in Spain yet, but this is surely only a matter of time, and especially when we come think about the large stock of unsold new homes (estimated at 500,000 as of March 2008) waiting on the books, and the drop in the number of mortgage loans mentioned earlier in this post.

Munchau correctly ties the capital inflows which have taken place to finance the previous boom with the huge balance of payments surplus Spain currently runs (Spain needs in the region of 9 billion euros in external finance a month to keep this afloat), but I'm not sure he has yet appreciated what a problem for the Spanish banking and indeed whole eurosystem this financing problem can become, since while he correctly points out that in the Spanish case "there can be no currency crisis....since Spain does not have its own currency", he omits to ask himself the equally pertinet question as to whether or not there could be a banking crisis. As I try to argue in this post there most certainly can.