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Monday, June 30, 2008

Spain Balance of Payments April 2008

Spain had a current account deficit in April of 8,726.9 million euros, slightly up on the 8,608 billion euros registered in April 2007. According to the Bank of Spain this deterioration is due to two factors, an increased in the goods trade deficit (oil), and a growing deficit on the income account (structurally not good news, but if you will borrow so much money, what can you expect?). As far as the trend in the current account deficit goes, during the January to April period the total deficit was 40.72 billion euros, while in the same months of 2007 the total was 35.245 billion euros. This is a year on year increase of 15%.

This rate of increase is considerably down on the 26.3% increase registered over January to March 2008, but since April this year is obviouslt such an unusual month (the Easter factor, data I am seeing from country after country for all kinds of items confirm this view, beware the ides of April) it would be very premature to draw any conclusions from this at this point. Other items worthy of note in this month's data are the fact that foreign banks sent funds into Spanish deposits again in April, which enabled Spanish banks to also transfer funds back out of Spain. More importantly perhaps, the liabilities of the Spanish banking system with the eursystem were up again in April, and sharply, by 15.869 billion euros.

The Trade Deficit

To get some idea where we are here, it is perhaps worth mentioning that the goods trade deficit was 7,198 billion euros in April ( up from 6,966 billion euros in April 2007), while the services surplus was 1,372 billion euros (up from 998 billion in April 2007). Over the January to April period the goods deficit was 31.653 billion euros (up from 26,788 billion euros in January to April 2007), while the aggreagte services surplus was 4,849 billion euros (up from 4,031 billion euros in the same period last year).

Both imports and exports were up substantially on the year (exports 25.1% and imports 18.2%) but since April is the month which normally contains easter, I don't think anything very interesting can be concluded about this at this point.

The negative income balance was up in April, to 1.909 billion euros, compared with 1.727 billion in April 2007. The balance on current transfers (which contains of course remittances from migrants) was a negative 991 millon euros, a deficit which was up around 10% on the 913 millon euros registered in April 2007. Again, as the Spanish economy slows it will be interesting to see how the remittances are affected.

In April the capital account had a positive balance of 258 millon euros, down from the 278 millon positive balance registered in April 2007.

The Financial Account

This large deficit in the Spanish current account - which resulted in a net financing requirement of 8.469 billion euros (up from 8.330 billion in March 2007) was basically (after taking into account the net movements on the financial account) covered by an increase in the liabilities of the Bank of Spain with the Eurosystem of 15.869 billion euros.

Spain's net external financial balance with the rest of the world resulted in an outflow of funds to the tune of 7.862 billion euros in April (as compared with a net entry of funds of 21.097 billion euros in April 2007). This increase in the inflow of external funds is very large indeed (and we will look in detail at some of the ingredients below), but the end result is that the net indebtedness of the Bank of Spain vis-a-vis the rest of the world was up by 16.053 billion euros in April (as compared with the net reduction of indebtedness of 13.771 billion euros in April 2007).

The net outflow of funds in April was mainly the result of changes in the category of "other investments" (which is basically made up by loans, deposits and repos), financial derivatives, and to a lesser extent portfolio investments.

Direct investments saw a net inflow of 1.05 billion euros, which was down on the net outflow of 5.186 billion euros in April 2007.

If we now come to repos, loans and deposits, there were net outflows in April of 6.013billion euros - while in April 2007 there were net inflows of 6.931 billon euros. Flows in and out of deposits at banks and other financial instutions are far and away the most important item here (about two thirds of the total, loans constituting most of the rest, while repos are pretty insignificant at this level).

The bottom line is that in April there was a movement of funds by Spanish financial institutions into deposits outside Spain to the tune of 16.846 billon euros while, on the other hand foreign investors moved funds into Spanish deposits and lent funds to the tune of 10.833 billion euros. As a result the lines on the chart below spike up again in April, although much less sharply than in January/February. Now let's see what happens in May.

Sunday, June 29, 2008

Spain Bank Lending April 2008

Spanish banks found more money to lend in April, and new lending on the month was up 6.755 billion euros, or a 10.3% year on year rate. This means that the banks have now been accessing new money at a more rapid rate virtually every month since last Decembers dramatic low. Of course what we don't know is how much they are having to pay to obtain this money.

At the same time the year on year percentage increases in new lending have still been dropping since January 2007.

Saturday, June 28, 2008

Has Artemio Cruz Suddenly Reappeared in Spain?

To find out the answer, and to read my latest complete analysis of the structural nature of the Spanish problem, you could do a lot worse than click over to the RGE Europe EconMonitor. Just to give you an idea, here's the first paragraph:

The Mexican writer Carlos Fuentes once wrote a novel entitled "The Death of Artemio Cruz". The novel begins with an elderly Artemio who suddenly finds himself awake and lying on his deathbed, gripped by repeated spasms of excruciating pain, and terrified even to open his eyes for fear of what it is he might get to see if he does. After years of debauchery and loose living (shade's of Oscar Wilde's Dorian Gray here) the thing which seems to frighten him the most is the possibility he might get to take a look at himself in a mirror.Of course, there are comparisons and comparisons here. Spain's economy is far from moribund, nor is it in its death throes. But Spaniards are suffering, and the process of adjustment is painful, and the attitude of the country's leader - José Luis Rodriguez Zapatero - does somewhat resemble the case of Artemio Cruz in that he appears, at least from the outside, to be totally obsessed with looking at anything that isn't an actual reflection of the actual state of the Spanish economy.And of course it's easy to criticise here, since the problems Zapatero is reluctant to look too closely at are serious ones, and worse still, it isn't at all clear that anyone really knows what to do about them at this point.

So what is the problem?... continue reading.

Spain Retail Sales May 2008

Well the horror story just gets worse and worse, doesn't it? This time it is retail sales that are out there trying to test the bottom. Retail sales in Spain fell 5.3 percent in May from a year earlier (price corrected), led by a 12.2 percent drop in purchases of household goods, the Instituto Nacional de Estadistica INE said yesterday in Madrid.

According to economists surveyed by Bloomberg, the Spanish economy faces a 45 percent probability of shrinking for two straight quarters before the end of 2009, up from 30percent last month. I don't know why people imagine we are going to have to wait till 2009 for this. I would say - looking at the retail sales and industrial output numbers - there must be a 50% possibility that Q2 2008 will show a q-o-q contraction, and its hard to find reasons to suggest why we should start expanding again in the next quarter, although we may well get some "bounce" in Q3 if the rate of contraction slows in some areas (it depends). In which case a good pair of candidates for straight q-o-q contraction might be Q4 2008 and Q1 2009. Of course both of these are before the end of 2009, so the economists saying this would be proved right in a very loose sense of the term.

Spanish Inflation June 2008

Spanish inflation accelerated to the fastest pace on record in June as oil and food prices rose at very strong rates. According to the flash estimate consumer prices rose 5.1 percent from a year ago after increasing 4.7 percent in May, based on the European Union's calculation method, the National Statistics Institute (INE) said on Friday. That's Spain's fastest inflation since the harmonized methodology was introduced in 1997.

This is now most preoccupying, since it now makes an interest rate rise from the ECB all but inevitable (for a good view of the policy debate vis-a-vis the ECB see this extensive piece from Claus Vistesen on RGE Monitor). The problem is that this sort of inflation almost certainly can't last given the rate at which the Spanish real economy might be slowing, in which case we will get monetary tightening going straight into the recession, with a non negligible possibility of provoking outright price deflation as a consequence, so I really do hope the ECB think very seriously about some of the potential implications of what they may be about to do.

Thursday, June 26, 2008

Spain Producer Price Index May 2008

According to the National Statistics Institute (INE), Spain's Producer Price Index registered a year on year increase of 7.9% in May 2008. The activities that most influenced this increase were the manufacture of coke and refined petroleum products (39.9%) and food and beverage products (10.3%). In terms of the final destination of the goods, the variation rates as compared with the same month the previous year were 5.3% for consumer goods (3.3% for durable consumer goods and 5.6% for non-durable consumer goods), 2.0% for capital goods, 5.9% for intermediate goods and 21.2% for energy.

Month on month the index registered a 1.2% increase with respect to the month of April 2008.

Now if we look at Producer Prices and Consumer Prices compared (chart below) we will observe how the producer price index suddenly shot up as of the middle of 2007, dragging the consumer price index (red line) in its wake. At the moment the rate of increase in producer prices is still on a very strong upward trajectory, which gives little confidence that producer prices are going to start to slow their rate of increase substantially any time soon, which means we may expect continuing pressure on the CPI, and hence continuing pressure on the ECB to raise interest rates.

Now to get some idea of what is actually happening here, maybe a comparision with the German PPI might be useful. Germany is, after all experiencing more or less the same energy and food price shock as Spain. So why is the German rate of PPI increase so significantly below the Spanish one (see chart below)? It wouldn't seem to make sense would it?

Well is we look at the comparative charts for nominal hourly labour costs we can soon see at least one significant part of where the problem is. After mid 2007 the paths of the two lines diverge (see chart below) with Spanish labour costs shooting up while the German ones trend down. And this remember while the German economy continued with a more or less healthy rate of expansion, while the Spanish one started to head towards negative growth. Why did Spanish wages shoot up in this way? Answering that question would probably get us a significant part of the way down the road to understanding why Spain, in addition to all the other macro issues facing it, also has th¡s really complicated and complicating cost inflation problem.

News and Data Roundup June 2008

According to the most recent data from the Spanish Ministry of Housing house sales fell 30 per cent year on year in the first quarter. On the other hand the Finance Ministry have revealed that the budget surplus was down to €2.72bn at the end of May from €13.6bn a year ago. Buying by non-residents, which previously helped fuel Spain’s 10-year construction boom, also fell in the first quarter, by 26 per cent year on year, and by nearly 50 per cent from the previous quarter.

According to a recent article in El Periodico - "The British Fall Out of Love with Spain" - “The British are starting to sweat in Spain, and not because of the heat....Mortgages payments for their properties on the Mediterranean coast have shot up...and the numbers no longer add up. Some are returning the keys to the bank, others are being evicted, and many are abandoning the dream of living in villas and apartments in Andalucia”.

The appreciation of the Euro against the pound (15% in the last 9 months), and the rise in the one year euribor means that mortgage payments for Britons with mortgages in Spain are now 25% higher than they were in August last year.

The web portal idealista.com are reporting that average asking prices for resale properties in Spain’s biggest cities fell by between 2% and 4% in the second quarter of the year over the previous quarter. We should note that these are asking and not selling prices. Selling prices are undoubtedly down rather more, although this is all really early days at this point. The cululative drop over the next 3 to 5 years is obviously going to be much larger, and the only real question is whether prices fall in one foul swoop, or drift steadily downwards.

Also El Pais reported this week that the Spanish banking sector needs to raise 62 billion Euros before the end of the year just to rollover the accumulated cedulas debt due 2008. This is no mean sum, and as the Spanish banking association says the liquidity crunch is a much more serious problem than the rising rate of mortgage delinquencies at this point in time. Up to then end of May the banks had raised some 20 billion euros, with 17 billlion of that coming from May alone. Just how much they are having to pay for this funding is not clear however, and over half the 20 billion has come from the Spanish banks buying their own cedulas.

El Pais scratches its head and asks just how the Spanish banks are going to "refinance" all the money which is coming due if the wholesale money markets remain closed to them. One interesting option they speculate on is offering better returns to lenders. But this would obviously mean Spanish banks and savings banks would need to raise the interest rates they charge their own clients. I find it interesting that people are already begining to speculate about the need for people to pay higher interest rates on their mortgages (remember we are talking about refunding the existing mortgages here, not new finance), since personally I imagine this is going to be an important ingredient in any longer term "rescue package". But redefining en-masse existing mortgage contracts would presumeably need legislation (I am no expert on Spanish law), and would obviously be far from popular with voters. But then, precious little of what the Spanish government is going to be forced to do from here on in is likely to be popular with voters.

Wealth Effect

According to the latest estimate from the Bank of Spain, for every 10,000 Euros fall in property prices, there is a corresponding fall in average household spending of 300 Euros per year. When the head of the household is in the 35 to 44 years bracket, the fall in spending is 600 Euros per year.

This is basically the well known transmission effect from property prices to private consumption known as the "wealth effect". Properties are the main form of collateral for household borrowing, so falling property prices reduce the ability of households to borrow and spend. The Bank estimates that for every 1% fall in property prices, household consumption is liable to fall by over 0.1%.

Land Prices

One of the big problems here in Spain is likely to revolve about what happens to the price of land. According to the latest data from the Ministry of Housing, land for building fell to 251 Euros/m2 in March, a 7.7% drop when compared with March 2007. Land prices have now fallen for 3 consecutive months, and at least as far as the official statistics are concerned, are currently falling faster than house prices. The average cost of land in Spain is now back to where it was at the end of 2004. Along with falling prices, the market for land has also been shrinking. Thn number of land transactions in the first quarter of the year was down by 31% compared to Q1 2007.

Spanish borrowing at the ECB

Returning to the theme of borrowing by Spanish banks at the ECB for a moment, and that notorius €208 billion ($320 billion) of eligible securities which have been created by eurozone banks since last August largely (everything but 5.8 billion euros according to JP Morgan) for use at the ECB, I have been noting how the Spanish banks are not standing out especially for their use of this facility, and have mainly drawn according to the weight of their share in the eurozone itself. One explanation for this may be found in the most recent appearance of Bank of Spain governor, Miguel A. Fernandez Ordoñez, before the Economy and Taxation Commission of the Spanish Congress. There he stated (June 24, p9) that Spanish banks have increased their participation in eurosystem fundings, "without going far beyond the equivalent participation in the key of Bank of Spain in BCE´s capital".

Las entidades españolas mantenían así una liquidez razonable y una amplia diversificación de plazos y segmentos de financiación cuando los mercados mayoristas en los que venían captando una parte notable de sus recursos colapsaron. Su capacidad de respuesta en este entorno de dificultad ha quedado patente en la adaptación que han llevado a cabo de sus fuentes de financiación, pugnando por captar pasivos tradicionales, desplazándose hacia plazos más cortos y, en el tramo final del pasado ejercicio, elevando su recurso al Eurosistema, aunque a partir de un nivel limitado y sin alejarse de la participación equivalente a la “clave” del Banco de España en el capital del BCE.

The Spanish banks low (although increasing)share on the ECB's weekly funding auctions (around 10%) may well be some kind of explicit or implicit limitation imposed by the ECB authorities themselves. Perhaps the rule is not to go much beyond the key suscription of the BDE on the ECB capital (it is 7.55%). This is the "clave" referred to by Ordoñez in the paragraph I quote in Spanish above.

José Luis Rodríguez Zapatero is finally due to appear before the Spanish parliament next week to offer his account of what is happening. It will be interesting to see just what exactly he has to say.

A fuller analysis of the whole structural problem in Spain can be found in this post here.

Tuesday, June 24, 2008

Spain Companies Created and Dissolved April 2008

One of the data points we will be following on this blog as the Spanish crisis develops will be the rate of creation and destruction of companies. The INE have just published the data here.

During April 2008 10,884 new companies were created, 12.0% fewer than in April 2007. The capital subscribed in their constitution was over 466 million euros, 36.4% less than in April 2007. In turn, the average capital subscribed registered an interannual decrease of 27.7%.

However if we look at the longer term chart, we can see perhaps a tendency towards a decrease in the rate of company creation since Q1 2007, but there have been spikes and troughs before, and there are good reasons to think that this time it will be different, and that perhaps we will get to see rather a large and extended trough. To be continued as the months progress.

In April, a total of 3,841 mercantile companies increased their capital, 12.4% more than for the same month of 2007. The capital subscribed in the increases registered an interannual increase of 9.4% and surpassed 3,622 million euros. The average capital subscribed in these operations decreased 2.7%.

On the other hand the number of companies dissolved in April was 1,178, a drop of 32.8% as compared with the same month of 2007. Of these, 85.0% did so voluntarily, 8.6% due to mergers and the remaining 6.4% for other reasons. Again there is considerable volatility in this data, but looking at the chart the rate of dissolution does certainly seem to have picked up since the middle of 2006.

Non Spanish Population Resident in Spain January 2008

The National Statistics Institute has just published the latest data from the Padron Municipal (valid as of 1 January 2008). 5,220,577 foreign born residents in Spain at that point. This was an increase of 701,023 over 1 January 2007. The evolution of the foreign born population can be seen in the chart below.

To give us some idea where we are here, Spain's population increased by 862,774 people during 2007. Natural increase in the Spanish population accounted for 161,751and the rest of the increase was a result of net inward migration.

Residents by country

Basically I would argue that the whole future evolution of the Spanish economy depends on what now happens to all these immigrants (who have basically compensated for the "missing births" in Spain which have been produced by the presence of lowest-low fertility for such a long time.

Here is a chart showing the principal migrant source countries outside of Western Europe. In Western Europe the UK is far and away the largest origin point, with 352,000 residents at the end of 2007. It is also interesting to note how the increase in the numbers of new residents from Western Europe has now slowed considerably. Now that the housing boom has fully burst it is unlikely the inflows from these sources will pick up very much in the near future.

Outside Western Europe the big news this year is that Romania has jumped into the number one slot, with 728,961 residents, overtaking the previous number one, Morocco (who now have 644,688 residents). The number of Ecuadorians actually dropped by 6,989 in 2007 and now stands at 427,099. It is hard to say anything conclusive about this, but at face value it does seem to suggest that the idea that East Europeans would be transient migrants and Latin Americans more permanent may be a large over-simplification. The Romanian community in Spain (as well as in Italy I suspect) seems now to be well established, and it may well be that many of these migrants have now decided to change their country permanently, we will see. If that is the case the implications of this (with 700,000 people largely of working age in Spain and a similar number in Italy) are enormous for the future of a country with a working population of only just over 10 million, and a population which due to its own low fertility would soon be contracting naturally. Unfortunately few people are thinking about this problem at this point.








Monday, June 23, 2008

The Spanish Treasury No Longer Accepts Italian Government Bonds

The Spain Treasury announced last Friday that it was no longer willing to accept Italian government paper as collateral for short term loans. In part the move is a reflection of the deteriorating liquidity situation inside the Spanish banking system, and in part it reflects the rather negative outlook on Italian government debt as continuing lowest-low economic growth makes it difficult to see how Italy can possibly hope to balance its budget by 2011, thus making holding Italian government debt a progressively more risky decision as that deadline approaches.

Spain's Treasury has said it is nopw only willing to accept the highest-rated government debt as collateral for short-term loans, a move that will exclude Italian government bonds. As of July, Spain will only take AAA rated bonds registered with the Spanish clearing house Iberclear as collateral for overnight repurchase agreements, or repos, according to Enrique Ezquerra, deputy director of public debt at the Spanish Treasury. Since Italian debt has been systematically downgraded in recent years, and Standard & Poor's now rates Italy's debt at only A+, while Moody's Investors Service has it at Aa2 this clearly means that Italian paper no longer qualifies. Italy's debt rating was lowered by both Standard & Poor's and Fitch Ratings in October 2006 on concern that problems in containing the deficit would lead to further increases in what is already the EU's biggest debt by volume over the coming years.

Basically the Spanish Treasury lends surplus cash to broker-dealers to boost income from financial holdings and in return receives collateral. Following the sub prime crisis in the United States last August the Spanish government expanded the range of securities it would accept as collateral to include foreign government bonds and AAA rated private debt since the strong budget surplus Spain was running at the time meant in had plenty of cash on hand.

Now Spain's budget surplus is rapidly disappearing as government spending rises in the face of the rapid economic slowdown while income is decreasing. Also, the Spanish banks, for whom this measure was really intended are finding themselves in an increasingly difficult liquidity gridlock, hence whatever help, no matter how small, they can receive from the government is more than welcome. Thus this move needs to be seen more in a Spanish than an Italian context. It is however a warning shot for Italy, since Italian paper (after its Greek equivalent) is the most difficult to place of any European government (and particularly given its volume), thus the Spanish decision can also be seen as a desire for the little window they have opened to become a repository for unwanted Italian debt.

In a Bloomberg interview Enrique Ezquerra described the move as "a partial step back....We will continue accepting AAA corporate bonds listed in the Spanish fixed-income market. This includes asset-backed securities and covered bonds.'' Perhaps I would say rather than a step back it is an attempt to close a loophole and focus attention on the real problem which is how to fund the Spanish cedula hipotecarias (the local version of mortgage-related covered bonds).

I would also say that this relatively small and seemingly trivial decision is just one more symptom of the sort of strains the eurozone's "twin deficts" (Italy's public debt - circa 103% GDP 2007 - and Spain's current account deficit - 12% GDP Q1 2008) are likely to place on the smooth working of the eurosystem ten years after it was originally set in motion.

Wednesday, June 18, 2008

Spain Construction Output April 2008

According to data released by Eurostat today, construction activity, when seasonally adjusted, fell by 0.8% in the euro area (EA15) and by 0.4% in the EU27 in April 2008, compared with March. In March, production decreased by 2.8% and 2.7% respectively. Compared with April 2007, output in April 2008 dropped by 2.4% in the euro area and by 0.3% in the EU27.

Among the Member States for which data are available for April 2008, construction output rose in ten and fell in three. The situation in Eurozone countries like Spain and Ireland contrasts sharply with the large increases in activity being recorded in some of the East European emerging economies, with Romania (+30.0%), Slovenia (+23.3%), Poland (+22.8%) and Bulgaria (+21.0%) leading the field. Spain had the highest annual decrease for any reporting country (-21.8%).

Sunday, June 15, 2008

Unpaid Bills of Exchange March 2008

According to the National Statistics Institute (INE) the number of unpaid bills of exchange increased in Spain by 24.4% in April as compared with April 2007. 4.2% of the total value of expired bills remained unpaid In April, the number of returned unpaid bills of exchange reached 486,396, which was a 24.4% increase compared with the same month of the previous year. The value of these unpaid bills reached 1,504 million euros, a whopping 83.7% increase as compared with April 2007.

I think the chart below says it all. Get ready!

In a separate report, the Bank of Spain has that said non-performing loans at banks and savings banks rose a provisional 16.5 percent to 22.457 billion euros in April from a month earlier. Non-performing loans as a percentage of the total granted to individuals and companies reached 1.25 percent, compared to 1.12 percent in March. The increase in non-performing loans is the result not only of soaring debt levels in the property sector but has also been fuelled by companies going into liquidation, particularly in real estate and construction.

Growth in Spanish bank loans will slow to a level "in line with nominal GDP growth," compared with rates of over 20 percent in the past years, the head of the Spanish Banking Association Martin Fernandez said this week. He suggested bank credit would grow in line with nominal GDP growth. Nominal economic growth (that is without allowing for inflation) is expected by the Spainsh government to run at about 5.5 percent in 2008. If loans grow at the same rate this would represent a sharp slowdown from loan growth of about 10 percent forecast by banks when they announced first quarter results in April. Equally, if loan growth runs at only this level it is hard to see the sort of nominal GDP growth the government is forecasting, so we are in a kind of circle here.

Saturday, June 14, 2008

Spain's Balance of Payments March 2008

Spain had a current account deficit in March of 12,049.5 million euros, which was well up on the 7.3114 billion euros registered in March 2007. According to the Bank of Spain this deterioration is due to two factors, the increasing trade deficit, and a growing deficit in the income account. If we look at the trend in the current account deficit we will find that in the January to March period (Q1) the total deficit was 32.552 billion euros, while in Q1 2007 the total was 26.637 billion euros. This is a year on year increase of 26.3%. If we now consider the fact that last years whole year deficit was an estimated 105.8 billion euros (or 10.1% of GDP) then if the first quarter trend continues then Spain could well be facing a whole year deficit of something in the region of 130.8 billion euros. (The current IMF WEO guesstimate is 171 billion dollars, or at todays prices roughly 110 billion euros). Now, Spain also has a major economic (credit crunch driven) slowdown underway and it is quite possible that GDP will be nearly stationary this year (let's say a maximum and very optimistic 1% whole year growth), so the value of the the deficit as a % of GDP is set to rise, and possibly very substantially, by between 1 and 2 percentage points. In fact given that Spanish GDP at current prices in Q1 was some 268.496 billion euros, the CA deficit was running at a rate of 12.12% of GDP. And to give us some idea that this way of doing things isn't entirely without foundation, we could note that the CA deficit during Q1 2007 was 24.89% of the whole year deficit. So where we go from here, it seems to me, depends on two things, the price of oil, and the rate of growth of the Spanish economy.

The Trade Deficit

To get some idea where we are here, it is perhaps worth mentioning that the goods trade deficit was up 4.5 billion euros in the January to March period over the same period in 2007 (or an increase of around 25% year on year), and since exports grew 2.4 billion euros while imports were up by 6.9 billion, then we can see that this story is virtually all about one thing: energy imports (since the rising income deficit - up 0.5 billion euros in Q1, or around 7.5% - while important for what it suggests about the future since Spain is having to borrow so much externally to keep afloat, is not determining over a short term horizon).

In fact exports were down in March, but since March was such an untypical month due to the calendar effect of Easter I think we are better staying with the Q1 data for the time being.

The Financial Account

This large deficit in the Spanish current account - which resulted (after taking into account a small positive balance of 223 million euros in Spain's favour on the capital account) in a net financing requirement of 11.8267 billion euros (up from 7.599 billion in March 2007) was basically covered by some very large movements on the financial account.

Spain's net external financial balance with the rest of the world was running to the tune of 17.8778 billion euros in March (up from 5.6969 billion euros in March 2007). This increase in the inflow of external funds is very large indeed (and we will look in detail at some of the ingredients shortly), but the end result was that net assets of the Bank of Spain vis-a-vis the rest of the world was up by 6.8635 billion euros on the month (a very large change from the negative balance of 773.9 million euros in March 2007. Now since things are going so stupendously badly as far as Spain's economy goes, we may well ask why things appear to be going so incredibly well on the flow of funds front. So let's take a look, since the answer we find may well be interesting.

The large increase in the net flow of funds, was mainly the result of a significant increase in the category of "other investments" (which is basically made up by loans, deposits and repos) while there were net outflows on all the other instruments in the account.

Direct investments saw an outflow of 2.3 billion euros, which was down on the net outflows of 6.272 billion euros in March 2007. There were net outlows to the tune of 14.343 billion euros in portfolio investments (largely bonds and equities) which contrasted with the large inflow under this concept 18.142 billion euros in March 2007. If we look at the appetite of foreign investors for Spainish bonds and equities the situation gets even worse, since in March there was disinvestment in Spain to the tune of 12.662 billion euros which compares with an inbound investment of 23.829 billion euros in March 2007.

If we now come to repos, loans and deposits there were net inflows in March of 34.831 billion euros - while in March 2007 there were net outflows of 6.404billon euros. Now we don't have a monthly breakdown of this data, since the Bank of Spain gives this on a quarterly basis, and the last quarter we have is Q4 2007, but as a rough rule of thumb we could say that flows in and out of deposits at banks and other financial instutions are far and away the most important item here (about two thirds of the total, while repos are pretty insignificant at this level).

The bottom line is that in March there was a massive disinvestment by Spanish financial institutions in deposits outside Spain - to the tune of 37.911 billone euros (bringing the money home?) which contrasts with net outflows in March 2007 of 18.846 billion euros. On the other hand foreign investors disinvested in Spanish loans and deposits by 3.080 billion euros which compares with inflows of 12.442 billlion euros in March 2007.

Something happened in March, but I'm not really sure yet what, and we need to see more data. If we look at the above chart (which contrasts the respective flows by the two agents - internal and external), essentially the balance doesn't tell you anything more than that it needs to be more or less maintained, and remember negative readings from Spanish agents mean positive inflows since they are disinvesting abroad). Essentially external lending and deposit transfers into Spain suddenly turned negative in March after two months of quite strong positive flows, and as a result Spanish financial institutions had to transfer money into Spain, otherwise it seems to me the whole domestic liquidity situation would have been like it was in December (when something similar happened, but the banks didn't move sufficient resources in and bank lending growth came to a virtual dead stop). Essentially as I say we need to see what happens under this heading in the coming months (and the next BoP data is going to be published on 20 June, so we shouldn't have to wait too long), but the volatility that has crept into these flows, and which is evident at the right hand end of the chart, is fascinating, and obviously indicative of things we are yet to learn about. What is most clear is how rapidly the Spanish financial agents need to react when external the appetite for lending to Spain slows. I think this may well be one of the clearest indicators we have of the impact of the current account deficit induced money drought.

In Brief Conclusion

In this post I have been focusing on Spain's growing current account funding problem, this issue is basically to do with Spain's lack of competitiveness in exports, and its very strong external energy dependence at a time when oil prices are rising substantially, and when the high price effect looks like it could be long term.

For some time the existence of this problem was hidden by the impact of the housing boom, and by the fact that this boom was increasingly financed by the issue of asset backed securities (ABS, cedulas hipotecarias). Thus during the boom Spain had no difficulty financing its deficit. But times have changed.

The Economist last week had a useful article about the way some banks have been "dumping" (they call the ECB a litter bin) ABS's on the ECB - and this is an issue I tried to draw attention to here. Perhaps the most revealing data point then mention is this one:

"Of €208 billion ($320 billion) of eligible securities created, only about €5.8 billion have been placed with investors, according to calculations by JPMorgan."

So some European banks (and in particular Spanish ones) have been increasingly creating paper for explicit use with the ECB. My feeling is that following all the publicity this issue has now been receiving the rate of new paper creation may well have diplomatically slowed, since if there is one thing Spanish banks don't like to do it is draw attention to themselves (unless of course the news is positive, which in this case it most decidedly isn't).

My general impression is that even the funding that they are currently getting from the ECB is insufficient since it covers only a small part of their needs and hence bank lending is rising at around 5% per annum instead of the 20% year on year rises we were seeing a year ago. So the Spanish banks are really getting starved of cash (or cash at a price which is interesting to them for mortgage lending), and hence all the frantic tooing and frowing we are seeing on the financial account.

Nowhere is this situation more clearly illustrated than in the case of the portfolio investment flows into Spain from foreign investors (basically bonds and equities), and as can be seen in the chart below these underwent a sea change following August last year. This is waht explains all the frantic moving around looking for funds we are seeing, since without the under other concepts Spain could soon become seriously short of money. At the end of the day, if you are sending money out every month to pay for your oil, where are you going to get the funds from for new lending? Desperate situations require desparate acts.

It is my opinion that here in Europe the most serious property issues are in Spain, Ireland and the UK. Spain may well be in the worst state due to the dependence on cedulas, and due to the fact that they need to start rolling these over soon - maybe 40 billion euros this autumn. So they have to refinance and find new money for future mortgages at one and the same time. Not funny.

And of course the Spanish economy is obviously contracting at this point, and last weeks transport strike must have been the last straw in some ways.

But, as we have seen here, on top of the credit-crunch property issues Spain also has a huge CA deficit one, and the problem is only likely to get bigger if oil prices keep rising. As I say at the start if GDP stagnates AND oil prices rise, then the deficit as a % of GDP (already running at 12.1% remember) may well continue to rise which makes this whole issue unsustainable on its own count.

Spain shares this CA problem with Greece (deficit 2007 13.9% GDP) and Portugal (deficit 2007 9.4% GDP) within the eurozone and these deficits have largely been masked by serving up "all eurozone" data where the large German surplus (surplus 2007 7.6% GDP) covers a multitude of sins. But German citizens are obviously NOT going to pay for Spanish oil (they may lend the money, but how long can this can continue to go up and up is anyones guess, it looks like an extermely exaggerated version of the US funding depence on Japan and China in some strange sort of way).

So the bottom line is that Spain is headed straight towards a crash on the two biggest global issues of the moment, the credit crunch and oil. The proverbial double whammy. Not pretty!

Thursday, June 05, 2008

Spain Services PMI May 2008

Spain's services sector shrank for the fifth month running in May, although the pace of contraction was slightly less than in April according to the May NTC Purchasing Managers Index. Staffing levels in the sector contracted at sharpest pace of the 9 year survey record and companies were pessimistic on the outlook for one-year ahead. The PMI for the Spanish service sector stood at 43.3 in May, compared with 42.5 in April and 56.2 in May 2007.

Any figure below 50.0 shows contraction while figures over 50.0 show growth.

For the first time in the near 9-year survey history, companies in the Spanish services sector were pessimistic overall regarding the outlook for activity in a year's time. The Business Expectations Index registered 49.3 from 54.7 last month.

"Cost pressures and faltering demand led many firms to believe that conditions could worsen in the year ahead," said Nathan Carroll, economist at NTC Economics.

Prices charged by the Spanish service providers fell in May, in a positive sign for Spanish inflation - the highest in the euro-zone - as companies slashed margins in an attempt to re-ignite demand. But this squeezed profit margins further for companies already crushed by higher input prices led by soaring energy costs.

Wednesday, June 04, 2008

Spain Unemployment May 2008 and the Worsening Real Economy

Unemployment rose in Spain last month for the first time in the month of May since 1979. The Spanish newspaper ABC notes in passing that the Spanish Economy Minister Pedro Solbes has finally managed to describe the situation as ‘serious’.

The number of people unemployed in Spain increased by 15,058 in May to a total of 2,353,575, according to the Spanish labour office INEM yesterday. The number of registered unemployed at the end of May was thus up by 0.6% from the previous month.

By sector, unemployment in the services sector was down 0.2% and also dropped 0.1% in agriculture. On the other hand, unemployment in construction was up 4.6% and was also up 0.8% in industry.

Year on year the rate of increase has been rising steadily, and was up 19.38% in May 2008 over May 2007.

OECD Outlook

The OECD also forecast that Spanish growth will more than halve to 1.6 percent this year and fall to 1.1 percent in 2009 as Spaniards cut spending and public accounts fall into deficit, the OECD said on Wednesday. I think from everything we are seeing these numbers are too high, and I think if you look at the very serious outlook for the financial sector in the second half of this year (see this accompanying post here) it is very hard to be so optimistic about short term stabilisation. This is going to get worse, a lot worse, before it starts to get better.

The OECD also forecast that the knock on effects of the abrupt fall in house building will send 2009 unemployment to 10.7 percent from 9.7 in 2008. Again this is begining to look very optimistic from today's data. Unemployment on the EU harmonised methodology is already up around 9.6% and seems set to continue to rise.

Also, perhaps here it is just as important to consider total employment as it is to think about unemployment, since so much of Spain's GDP growth in recent years has been labour input driven and not productivity driven. In fact total employment seems to have peaked in Q3 2007 at 20.511 million. The question is now just how far and just how fast is this going to come down. To get an idea the rate of increase has been dropping by the quarter since the maximum rate of acceleration with seemed to be a year on year 4.91% in Q1 2006. By Q1 2008 we were at a y-o-y increase of 1.66% and we are of course dropping. Since there is very little productivity change going on here the rate of change in the employed population will probably constitute a pretty good proxy for the rate of GDP growth.

The OECD also forecast that Spain's public sector budget will fall into a deficit and be equal to approximately 0.3 percent of GDP in 2009, following five years of surpluses, due to a 10 billion euro economic stimulus package, lower tax receipts and higher infrastructure spending. They anticipate the economy will be sluggish for 18 months (I think we are into something much longer term than this).

Spain's inflation, which is currently among the highest in the euro zone at 4.7 percent, should finish 2008 at 4.6 percent before easing to 3 percent in 2009, the OECD said (this may well be much more realistic).

Credit growth will ease as Spanish banks, especially small savings banks or cajas, struggle to raise external capital. House prices will feel downward pressure as more new homes enter the market with construction firms finishing off the large number of housing projects begun in 2007. Investment in machinery and equipment, one of the most robust areas of the Spanish economy, is expected to contract on weaker demand, waning confidence and more restrictive financial conditions the OECD said.

Spain's current account deficit, the world's second largest (after the US) in absolute terms in 2007, will remain around 10 percent of GDP over the next two years as higher import prices and external debt service payments offset a fall in imports and slightly stronger exports.

Consumer Confidence Hits New Low

Spain's consumer confidence index fell again sharply to 56.4 in May from 63.8 in April, the lowest level since the indicator began in September 2004, the state financing agency Instituto de Credito Official (ICO) said.

The indicator looks at consumer confidence in the current economic situation and future economy in terms of the country, the home and employment.

The index May figure reflects declines in all categories from April, with sentiment on Spain's economy down 6.7 points, on employment down 2.8 points and on household economy down 6.2 points.

Consumer confidence was 39.3 points lower in May from a year earlier, when the consumer sentiment index stood at 93.0.

There is also increasing evidence of a widening divergence between the big four economies in the 15-nation eurozone with Germany and France continuing to prop-up a contracting Italy and a Spain which is in "free fall". This divergence is only going to add to the headaches over at the European Central Bank, which is already pretty worried about the continuing high inflation. After a drop in April, the Business Climate Indicator (BCI) has stabilised in May. The Economic Sentiment Indicator (ESI) remained unchanged in the Eurozone at 97.1.

Car Sales

Spanish car sales fell almost a quarter in May, offering further evidence the Spanish economy is cooling far faster than expected, but French sales were up, bucking weak consumer confidence, and sales in Belgium also rose.

Spanish dealers sold 116,108 units in May, 24.3 percent fewer than a year ago, industry body ANFAC said on Monday.

In the year to date, car sales were down 14.3 percent at 587,407 units, almost 100,000 less than a year ago and the lowest total since at least 2002.

Retail Sales

Spain's retail sales fell 3.4% in April and continue to fall.

Industrial Output

Spanish industrial output adjusted for calendar effects fell 2.6 percent in March from a year earlier, according to the latest data from the National Institute for Statistics (INE). INE also said consumer goods output fell 4.6 percent from a year earlier, while capital goods output was down 0.4 percent. Intermediate goods output fell 6.9 percent, while energy goods output rose 10.2 percent.

Monday, June 02, 2008

Spain Manufacturing PMI May 2008

Spain's manufacturing activity continued to decline in May, and, more importantly, it continued to decline at an ever increasing pace. This is what I mean by problem in the financial sector steadily spilling over into the real economy.

The Spanish manufacturing sector purchasing managers' index (PMI) fell to 43.8 in May from 45.2 in April, the fourth consecutive drop, market research group NTC said. The figure is the lowest in six and a half years, NTC said.

'The Spanish manufacturing sector continues to fall due to the end to the construction boom. May's PMI figures show a record drop in new orders as businesses and Spanish consumers react to the new economic climate,' economist at NTC, Nathan Carroll said.

A reading above 50 indicates that the manufacturing sector is generally expanding, while a reading below 50 suggests it is contracting.

Sunday, June 01, 2008

Are Spain's Bank's Facing A Short Term Liquidity Crunch?

Last Monday morning when most of Spain's citizens were busy watch YouTube videos or TV coverage of Rodolfo Chiquilicuatre doing his buffoonery at the Eurovision Song Contest, many readers of the English speaking press were hard at it peering into another video, the one of the FT's Ralph Atkins interviewing Spain's representative on the ECB executive board José Manuel González-Páramo (transcript here, curiously whilst almost everyone in Spain seems to know who Chiquilicuatre is, almost no one has heard of González-Páramo).

The Spanish representative was busy trying to allay fears that European banks have become over-dependent on European Central Bank liquidity injections and in particular trying to deny that the Spanish banks are gearing their operations to take advantage of its extra help.(In other words while good Rodolfo was dando-nos a todos verguenza ajena, González-Páramo was simply doing his job, and dando la cara).

“I don’t think in any way the banking system is becoming addicted,” said José Manuel González-Páramo, ECB executive board member, in an interview with the Financial Times. “They are now behaving a little bit different than they were behaving before August 2007, but the reasons behind that are quite obvious to everyone.”
If González-Páramo was having to work hard to keep the Spanish end up, this was in part a response to the growing concern that Spanish banks are creating ever riskier collateral to swap with the ECB, far riskier collateral than the central bank ever envisaged (see below), that the ECB already holds too much risky collateral, and that the funding was being used to far to great an extent to keep "business as usual" going, rather than bridge finance to enable a sizeable restructuring of the Spanish economy. Just such a view was expressed earlier this month by Yves Mersch, Luxembourg’s central bank governor – who, like Mr González-Páramo, sits on the ECB’s governing council – when he indicated that the type of collateral now being accepted by the ECB was “a matter of high concern”.

Since the global financial market crisis erupted last year, finance houses have been able to fall back on the ECB’s liquidity operations, available to a large number of banks on the basis of a broad range of collateral, including some mortgage-backed securities. To address financial market tensions, the ECB has also altered the way it provides finance.

Slowdown in Bank Lending

Evidence of the difficulties that Spain's banks are having is everywhere. Take bank lending for example. According to the most recent data we have from the Bank of Spain, lending to Spanish households was up by 4.245 billion euros in March when compared with February, and year on year lending to households was up by only 10.6%.

I say "only" here since this rate of increase in lending is only about half what it was at the start of 2007, and as such it is only about half the rate of new mortgage generation that the extensive Spanish construction industry needs simply to keep turning over.

The reason for this decline in the rate of new lending creation is obvious: the liquidity crunch, which is now the principal reason why Spanish banks are steadily lending less and less extra money in new mortgages each month, although evidently since all of this is now producing a substantial slowdown in the real economy, with unemployment rising and take home pay under constant pressure from inflation we are steadily moving from a construction crisis fuelled by a lack of availability of funds for mortgages to one which will be increasingly driven by absence of demand for them as the "affordability" issue steadily locks-in on those who would like to buy their own home.

The fundamental situation is that since the Spanish banks are short of cash they are simply able to lend less. It is this, and not the 4% repo rate set by the ECB, which is the principal reason the value of mortgages created on urban buildings in Spain (at approximately 16,575 million euros) was down in March 2008 by 36.7% over March 2007. In housing, the capital loaned exceeded 9,975 million euros, 41.9% less than in March 2007. 105,608 properties were mortgaged in March 2008, a decrease of 37.77% over March 2007.

The Spanish banks are, of course, able to raise money, but much of this is on a short term basis, and not appropriate for long term lending on products such as mortgages. Moody's recently suggested that Spanish savings banks are trying to attract foreign investors (especially German pension and investment funds) with private placements of tailor-made securities. But such issues are typically in the 30 to 300 million euro range - a far cry from the earlier jumbo cedulas. In addition maturity on these securities is much shorter, typically three years. (To those readers who have no idea at this point what cedulas hipotecarias actually are, I would say fear not, since neither did I when I set out on this venture, but perhaps it is worth reading through my working notes on the topic since they may help you become just a bit more familiar with the meaning of an expression which is - unfortunately - only too likely to become as much a part of the 2008/09 economics lexicon as "sub-prime" was in the 2007 one).

Another strategy the banks have been using has been to issue short term (typically three month) paper, and there was roughly 90 billion euros worth of it outstanding at the end of March. Banks are also trying frantically to attract more deposits, and since the end of last year some 20 billion euros have been transferred out of investment funds into long term deposits. The however do not come cheap, and the price the banks are paying for this money is prohibitively expensive - some of it even pays 7% - for it to be used as a basis for mortgage finance, for mortgage finance since mortagages are still widely on offer for around 0.5% over 1 year euribor (or 5.25% or so).

Thus the problem for the banks is really how to find a stable long term source of finance for their mortgage business given the fact that the wholesale money markets have been virtually closed in their faces. In this connection the Financial Times's Leslie Crawford had a piece in the May Issue of Financial World which examined some of the funding problems the Spanish banks are having. As Crawford says "with every month that the capital markets remain closed to them, the problems of the Spanish banks grow more acute". And since we have no idea at the present time at what level Spanish property prices will finally settle (and thus what the true market value of the pool of mortgages which effectively backs the cedulas actually is) then it would seem that the day the doors will once more open again (at least at prices the Spanish banks would be interested in) is far from being at hand.

Crawford cites the Madrid based consultancy Analystas Financeros Internacionales (AFI) to the effect that during Spanish banks were raising approximately 40% of their funding requirements outside Spain at the height of the boom, as compared with only 15% in 2000-2001.

According to AFI foolowing the August blow-out the Spanish banks and savings banks did continue to issue residential mortgage backed securities (cedulas) in the second half of 2007 (to the tune of an estimated 50 billion euros, although this number seems rather high to me), but none of these were placed with external investors (since there were effectively no takers), but rather they were kept on the books for use in repo facilities with the ECB as needed.

Data from the Bank of Spain show that Spanish banks have doubled their share of the ECB's weekly funding auctions since August 2007 - up to 10% of the total from a previous 5% - and that in February Spanish banks borrowed 44 billion euro out of a total 442 billion euro.

The big issue is of course that there is now no market for the earlier jumbo bond offerings. Worse, many of the original jumbos were offered with maturities of between five and eight years. So these cedulas will effectively soon be coming up for rollover.

I would say that the greatest risk points for the Spanish economy at this stage are:

1/ the potential liquidity crisis which may be constituted by the need to refinance the cedulas.

2/ the potential increase in the quantity of bad debt provision which the Spanish banks may need to set aside as and when the builders themselves start going bankrupt in serious style. With anything up to an estimated 1 million unsold properties on the books in Spain at the moment, and with the banks being de facto owners of these properties through their financing of the builders, this avenue is the most important short term threat of debt delinquency, and not unpaid mortgages (IMHO). And the sums involved are by no means chickenfeed, and could well be very similar in magnitude to the quantities owing on the cedulas. ie the whole problem is very large indeed.

Of course later, as the financial problem ripples its way through the real economy, the ability of individual households to meet their mortgage obligations may well become a problem, but we are a long way from that at this point, and sufficient unto the day is the evil thereof is very much the case here I think.

AFI estimate that around 40 billion euros in cedulas and other bank debt come up for refinancing in the second half of 2008, that in 2009 this number will rise to around 80 billion euros, and that the number will remain high through 2010 and 2011. That is to say my rule of thumb guess that we may be facing around 300 billion euros in rollover issues (or around 25% of Spanish annual GDP) in the coming years does not seem to be too far off the mark. And as I say, we may need to make similar provision for equivalent exposure to bankrupt builders etc.

According to this report in El Economista the President of the Confederación Española de Cajas de Ahorro Juan Ramón Quintás has been in discussions with the Spanish government about the problems the regional savings banks are having and are going to have, and one of the solutions under discussion is that the fondo de Reserva de la Seguridad Social should buy bonos and cedulas to help with liquidity. Help! Well it's not my pension they may be about to start playing with, but still.