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Saturday, December 27, 2008

Spain's Recession Finally Becomes Official

Well first of all, let me wish a very Merry Chrismas to all my readers. I hope everyone is having a good break, and not spending too much time worrying about what gets to happen next year, especially since worrying doesn't change anything, although maybe doing something does - but that is probably where all those famous New Year resolutions come in. I don't think you can change the world, but you can change how you live with it, and you can change what you yourself do. And by making changes yourself maybe you can influence the changes others make, and thus, indirectly, if quite slowly, change the world. So maybe that is what we should all be working on, to try and do the best for Spain in 2009. And with that little homily, let's get back to taking a look at what's been going on in Spain over the last week or so.

Q4 Contraction Confirmed

Well first off, and it doesn't really come as any surprise, the Economy Minstry confirmed earlier this week that on their estimates Spain's economy contracted during the fourth quarter (not exactly any kind of surprise this), but it did more or less bring the agony of waiting to an end, and the country's first recession in 15 years (the last one ended in 1993) is now just about as official as it is likely to get.

The Ministry felt able to say this because their Indice Sintético de Actividad (or synthetic activity indicator -ISA), which uses a number of proxy variables to try to track Spanish GDP, contracted by 1.5 percent (year on year rate, we still have no idea of the q-o-q rate) between October and December. (You can find an ISA table with text in Spanish here).

This is of course Spain's second consecutive quarter of shrinking growth (I can't imagine there is anyone in Spain who doesn't actually know this already), following a quarter-on-quarter GDP contraction of 0.2 percent between July and September. It is worth bearing in mind, however, that this is only a very approximate indicator, and it doesn't seem to track the final result very closely at all if you look at the actually chart. So I think we need to wait for a more accurate reading which will only be given to us when Spain's INE releases preliminary fourth quarter GDP data on February 12, although a pretty good approximation will be available in the Bank of Spain bulletin to be published at the end of January. Anyway, for what it is worth, here (see below) is what the year on year growth chart would look like if the 1.5% number was anywhere near reality. Pretty horrid, isn't it? I don't think we should assume it will be this bad, but the number we really need to see is the seasonally adjusted quarter-on-quarter one, since that will tell us just how rapidly Spain's economy was contracting during the quarter, and tell us more or less where we are at this point. The contraction was pretty fast would be my guess, maybe 1% or even more, given the very strong data we have been seeing recently.




Bank Credit Continues At A Pretty Low Level

“There is a burgeoning economic crisis in the European periphery,” Krugman said on the ABC network Dec. 14. “The money has dried up. That’s the new center, the center of this crisis has moved from the U.S. housing market to the European periphery.”

We now have Bank of Spain data for bank lending to households and companies in October, and while the numbers look considerably better than those for August and September, the improvement is only relative, and there is still a pretty strong credit crunch going on out there. I don't know whether or not Krugman has Spain in mind when he spoke of the European preiphery (he almost certainly was referring to the situation in Eastern Europe), but if he did, he wouldn't have been far wrong. As we can see from the chart below, the banks had been struggling to find money for household lending right through the first half of the year, but after July the position really went straight off the map, and even though, as I say, the October number picks up, it still shows lending running at a very low level.




Lending to corporates has kept up better than lending to households (another way of looking at this would be to say that the mountain of debt has just kept on growing, and that the need to support the walking dead has been one of the reasons so little of the available cash has been finding its way through to end consumption), but it is still falling steadily in year on year terms.





Are The Cracks Now Appearing In The Spanish Administration's "If It Moves Deny It Exists" Approach?


Bank of Spain governor Miguel Angel Fernandez Ordoñez walked into the headlines last Sunday by issuing a bleak assessment of the current economic crisis, even going so far as to warn that the world could face a "total" financial meltdown - something he stressed had been unseen since the Great Depression. I am sure the danger of even more things going wrong is out there, and is real, but personally I found Ordoñez's comments a little exaggerated - or at least not really in keeping with the kind of sobre and measured evaluation of events you expect from a central banker, and not exactly in line with the "good housekeeping has meant that Spanish banks don't have a problem" approach he has been serving up since August 2007. I mean, if we are simply talking about the financial dimension of this crisis, well the worst may well now be over in many of the world's major economies, although this is not the same thing at all as saying that the worst of the impact on the real economy is over, indeed as I explain in this post, that part is only just begining.

Indeed, (again as I explain in this post), this was precisely the pattern we saw in the Great Depression, when a very serious financial crisis in 1929 and 1930 was followed by a serious contraction in economic output from 1930-33, and then by a very slow recovery from 1934 till WWII. Unfortunately we may now repeat some of that pattern again (from a lot richer starting point, of course), with a serious financial crisis in 2007/08, and then an economic slump from 2008 to 2010. Even worse, there are reasons for thinking that even then the recovery may again be a slow one, since with everyone trying to deleverage, and move from being net consumers to net exporters, we end up being left with that tricky little question of just who is going to do the consuming, and who is going to buy all those exports. Anyway, at this point I think we could usefully leave that rather theoretical topic for the future, and focus a bit more on the coming recession, since if we don't manage to focus on it, it will darn sure focus on us.


So, as I say, Ordoñez does seem to be a bit exaggerated in his choice of words, unless...... unless what he really had in mind was not a generalised financial meltdown, but a meltdown in a number of key countries (Krugman's European preiphery), and even more specifically in this case, a meltdown in Spain. This I think is a much more credible explanation, and methinks that what he was actually doing was using politically acceptable code language to talk about Spain (since no one ever seems to actually say what they really think here at the present time - you know, "a mal tiempo, buena cara").

Some support for this interpretation can be found in the most recent Economist Intelligence Unit country summary on Spain - bemusingly entitled Spain economy: In need of support. I say bemusingly, since they don't make clear whether the support Spain's economy needs should come from the national government, or whether the issue is now so large that such support will have to come from outside (which is my own personal view). Anyway, the EIU do draw our attention to one possible explanation for the Bank of Spain Governor's recent outburst, and that is that the Spanish administration is now a house divided unto itself. That is, there are quarreling factions.

One consequence of the recent policy measures is the emergence of two discernable factions among the country's leading policymakers. On the one hand, Mr Zapatero favours a strongly expansive fiscal response and hands-on public-sector engagement in the real economy—an approach that is backed by the increasingly influential minister of industry, commerce and tourism, Miguel Sebastián.

In the opposite corner the minister of the economy, Mr Solbes, and the governor of the Bank of Spain (the central bank), Miguel Ángel Fernández Ordóñez, are both displaying visible concern about the consequences of unbridled fiscal expansion and the public appropriation of private risk. Mr Solbes recently spoke of the dangers of an excessive deficit, while Mr Ordóñez has warned the government that it runs the risk of leaving itself with no room for manoeuvre if the economy continues to deteriorate for a protractedperiod.
Well basically all of this makes a lot of sense to me, and I have been picking up in earlier posts here on just how the Bank Governor has been trying to draw attention to the way that deficit spending was getting out of hand. Indeed, I myself have been expressing exactly these kind of concerns here on this blog. Now let's be clear, the problem is not that Spain is running a fiscal deficit at this point, nor even that this deficit is likely to exceed the EU 3% of GDP limit. Exceptional circumstances demand exceptional measures, and obviously we need quite a strong fiscally-driven injection of some kind at this point - the issue rather is that the Spanish government need to think very carefully about what they are doing with the money they are raising and spending. If they spend the money on more and more construction activity, on the basically eroneous assumption that this is simply a cyclical rather than a structural crisis, then they will simply make things worse in the longer run, since they are using up badly needed ammunition.

"The lack of confidence is total," Miguel Angel Fernandez Ordonez said in an
interview with Spain's El Pais daily. "The inter-bank (lending) market is not
functioning and this is generating vicious cycles: consumers are not consuming,
businessmen are not taking on workers, investors are not investing and the banks
are not lending. "There is an almost total paralysis from which no-one is
escaping,"

I think Ordoñez is talking about Spain here (and possibly the UK, and Ireland, maybe Italy... but not France, and not Germany, where despite serious problems the issues are different). Ordoñez also added that any recovery, which the "optimists" (read Zapatero and Sebastian) are pencilling-in for the end of 2009 and the start of 2010, could well be delayed if confidence is not restored. I wholeheartedly agree, and indeed I have the most serious part of the Spanish crisis "pencilled in" for 2010/11 - if the car makes it that far without one of the pistons seizing up that is.

The Straw That Broke The Camel's Back?

Ordoñez also suggested that the European Central Bank, of which he is a governing council member, would probably cut interest rates in January if inflation expectations went much below two percent. "If, among other variables, we observe that inflation expectations go much below two percent, it's logical that we will lower rates." he said. This again was noteworthy, since ECB President Jean-Claude Trichet had been busy stressing, only a couple of days earlier, that there was a limit to just how far the central bank could cut rates, even going as far as to suggest that in his opinion the bank might decide to pause in January, despite the fact that even the bank's own forecast indicates that the entire eurozone economy will contract in 2009.

Ordoñex also made plain that in the event “expectations of deep deflation” should emerge in the Eurozone then he personally would be in favour of following the same policy of quantitative easing the Federal Reserve has deployed, cutting in the process the target lending rate to near zero.But this simply begs the question, what does the ECB do if deep deflation expectations develop in some countries and not others?

He also said he thought that credit growth would probably match nominal gross domestic product growth next year, which is interesting, since if we do get deflation in Spain, nominal GDP will fall, and this would seem to imply that bank credit might even fall. As we have seen above, on a year on year basic credit is still growing faster than gross domestic product, but it is slowing continuously, and over the last four months has hardly moved.

Tourism Hit From Britain

Of course, at this point in the game events in one country have an impact on events in another, and Spain is especially vulnerable here due to the strong dependence on external tourism. Arrivals of foreign tourists to Spain were sharply down in November as Britons and Germans increasingly worried by their own internal situation (and the falling pound) stayed at home in increasing numbers. Total arrivals were down 11.6 percent over November 2007, with tourism from Britain down 15 percent, according to data last week from Spain's Industry, Tourism and Trade Ministry.

Tourism is Spain's second biggest industry and leading destinations Catalonia and the Balearic Islands suffered falls of over 10 percent in November. Foreign tourist arrivals were down an annual 2 percent - to 54.6 million - in the 11 months from January to November.


Bankruptcies On The Rise

Over 1000 Spanish property and building firms have filed for bankruptcy protection in 2008 and more than 1300 could follow in their footsteps next year (as they struggle to repay an estimated 470 billion euros in debt), according to the latest report from Price Waterhouse Coopers. Analysts at Credit Suisse (in a separate report) estimate that the non-performing loan rate will rise to 9 percent by 2010, up from the current 3.5 percent at present, threatening the solvency of the regional savings banks that hold over half of all property debt.

Of course in all of this it is important to realise that most of the numbers are just guesstimates, but the 470 billion euro in debt attributed in the press to LSE economist Luis Garicano t (315 billion in developer loans and 160 billion in builder loans) seems firmly rooted in Bank of Spain data, and this quantity is enormous.

In 2008 alone, the Spanish banks have had to swallow around 15 billion euros of bad loans from builders, lentfirms 5 billion for assets to stave off bankruptcies, and taken on board another 5 billion in debt-for-equity deals, according to the newspaper El Mundo. Credit Suisse take the view that bad loans at larger, publicly traded banks like Santander and BBVA should remain at manageable levels around 4 percent, but they suggest that some regional savings banks, with higher property exposure, could see rates of 12 or 13 percent in two years and face capital shortages.


Asked whether Spanish lenders would need recapitalizing, the central banker said
this “depends on one’s hypothesis.” Spanish banks are facing difficult years
ahead, and some institutions will merge, he said. Still, regular banks are less
fragmented than Spain’s savings banks, which are tied to autonomous regions and
channel profits to social projects, Ordonez told the newspaper El Pais.
“Logically, if results fall, mergers are very possible,” he is cited as saying.
“Common sense indicates there will be mergers.”


House Prices Falling - But How Far And How Fast?


One of the biggest mysteries about what is actually happening in Spain concerns Spanish property prices, which if you accept the figures published by the Spanish housing ministry have barely fallen so far (down just 0.5% in 2008). No one really accepts this number as "good", but there is little real consensus at this point about what a more accurate figure would be, or what we can expect in the future. A number of banks have now expressed an opinion, most recently Spain's very own BBVA, who now estimate prices will fall “close to 5% in 2009 and 10% in 2010" leading to a total fall of 25% by 2011. They thus joinn the Swiss banks Credit Suisse and UBS who have already forecast a drop of 30% over a similar time frame. For my own part I think there are so many unknowns at this point that all estimates must surely be of a rather symbolic nature. All I think that we can say is that the drop is going to be large and substantial.

BBVA also dip their toes in the water by offering an estimate of the size of the inventory of new homes languishing on the market. They put this number at anywahere between 800,000 and 1.4 million, rather above the Ministry of Housing’s current estimate of 650,000 unsold new homes. Neither BBVA nor the Ministry offer figures for the number of resale properties on the market. BBVA also estimates that housing starts will drop to 200,000 per year, down from more than 800,000 in recent years.

This does not seem an unreasonable suggestion, and housing starts in the province of Barcelona have fallen dramatically recently - according to the Catalan College of Architects - down by 83% year on year in October, with just 646 new residential construction projects being started, compared with 3,792 in October 2007. The slowdown in housing starts even seems to be accelerating, since the drop in the first 10 months of the year was 64.5%. Construction was down for all types of property, with flats falling 84%, semi-detached properties down 91%, and villas down 65%.

On the other hand many developers are still working to finish homes which were first set in motion during the boom years, and in the first 10 months 2008, incredibly they finished 12% more homes than last year, though again construction completions have started to fall as the year has advanced, with October completions down 33% compared to last year.

And the dramtic drop in new building starts isn't simply restricted to Barcelona, with new starts in the province of Alicante (Costa Blanca) falling to the lowest level ever recorded, according to reports the Spanish press. The number of residential construction licences issued in Alicante has fallen to just 720 in 2008 from 4,165 in 2007. The previous record low for building permits in Alicante was in 1996, when just under 2,000 licences were granted, almost triple the amount this year. The record high was 2003, when close to 4,500 construction licences were issued.

All of this simply confirms the estimate of José Luis Malo de Molina, head of research at the Bank of Spain, who stated that building completions in Spain in 2008 would be an all time record - beating even last year’s previous high of 641,419 completed properties, but that then the fall of the cliff would be absolutely brutal, with developers forecasting just 150,000 housing starts next year, compared to 250,000 this year, and more than 600,000 last year.

And to cap all this of, Spain's Association of Property Experts (REI) announced recently that resale property transactions in 2008 are down 70% on 2005, a “much bigger fall than is reflected in the official figures from the Ministry of Housing,”, according to REI, since the Ministry of Housing includes inheritances and gifts as ‘transactions’ in the total figure.


More Debt Purchases

The Spanish government is going back to the (reverse) auctions next month, will buy up to 4 billion euros worth of assets from banks on 15 January and up to another 6 billion euros in a second auction on 30 January. These purchases will be added to the two previous ones - on 11 December 11 the government bought 7.2 billion euros in mortgage-backed debt from 31 banks and on 20 November it acquired 2.1 billion euros in debt from 23 banks. The purchases will be made by Spain's Fund for Acquiring Financial Assets, which was set up to provide an alternative market for banks to issue long-term debt. Spain plans to buy up to 50 billion euros in bank assets over the next twelve months.

Immigrants Making The News

Immigrants have increasingly been making the news in Spain, and the eye of the press has been caught in recent days by Ubeda, a small Spanish market town in the heart of the olive-growing region of Andalucía. What has been attracting attention is the presence of unusually large numbers (hundreds) of unemployed Africans waiting on street corners, hoping someone will turn up and offer them work . The pressure is such that Ubeda’s indoor sports centre has been converted each into a giant temporary dormitory to offer some kind of shelter to the homeless Africans.

Such migrants have now been arriving in Spain's olive growing regions for years, but never in the present numbers or with so little chance of finding a job, according to local officials. The general impression is that the towns and villages of Jaén province have been flooded with thousands of destitute jobseekers in need of food and shelter. On the busiest night so far this year Caritas, the charitable arm of the Catholic church, fed something like 700 hungry immigrant jobseekers, and this in a town whose total population is 34,000.


The migrants – most of whom are from Senegal and Gambia, although there are some from Algeria and Morocco and a few from Romania and Bulgaria – are hoping that a jefe, or farm boss, will drive past in a van or a tractor, and offer an olive harvesting job that will often pay something in the region of 46 euros per day. Basically there are more migrants than ever looking for such work this year, while the number of jobs on offer is down since Spanish workers who previously shunned farm jobs are beginning to accept any work they can get and are often given preference by Spanish employers.

There are roughly 5 million immigrants in Spain, and they make up about 10% of the population, the highest proportion in the European Union. Even more strikingly, more than 4 million of these immigrants came to Spain after 2000, during the good years of the housing boom, they filled the toughest and worst paid jobs on building sites and farms. The connection with the housing bubble is evident. But now these workers are losing their jobs at twice as fast as Spanish born citizens, with unemployment already around 3 million and rising rapidly. The future of this population is one of the topics I will follow on this blog, since they are evidently among the most vulnerable, and the most exposed to the crisis.

Monday, December 15, 2008

Going For A Song

Well, this is a bit outside the range of my usual posts, but the following just showed up inside my gmail Google Ads. They are offering properties at 50% of bank valuations, and with even bigger discounts for "bulk purchases".


Spanish Repossession Property – Direct From the Bank:

As a lot of you will know, we have dabbled in the Spanish market for a few years now. Dealing mainly with sellers who need to sell quickly and we have had a few good deals going through. But as I’m sure you are aware, in Spain the “Real Deals” are from the Banks who have repossessed property and are looking to just recover their loan amount and move on! This area has always been closed off to us with the sales going to “The Old Spanish School Tie Brigade” even after many attempts over the last couple of years to “get on the inside”.

The good news is that we now have a direct contact with a large Bank in Spain, through a Spanish firm of lawyers who have been instructed to dispose of the banks repossessions on an exclusive basis. They also deal with the whole buying process,tax and legal issues plus mortgages (They have negotiated up to 80% mortgage subject to certain bank requirements and individual situations).

The bank deals with properties in the Murcia, Alicante, Almeria areas only. Discounts vary from property to property but some can be purchased for around Half The Bank Valuation Figure and there are further discounts for bulk purchases. Another plus is that they are already holding bank valuation figures for every property. All properties are owned outright by the bank.

If you would be in a Serious Position To Take Advantage Of This,bla, bla, bla......



Ireland To Invest From Pensions Reserve Fund For Bank Recapitalisation


Now here's an interesting precedent to watch out for in the future, the Irish government has announced today that it is planning an investment of "up to €10bn" in the country’s banks, in partnership with private investors. The planned recapitalisation, announced in a statement by the finance ministry late on yesterday, is aimed at strengthening the balance sheets of the banks and restoring investor confidence in bank shares, which have fallen sharply in the last week. The government has indicated that it plans to use money from the National Pension Reserve Fund, a sovereign wealth fund with assets under management of €18bn which was established to part fund the future public service pensions. According to the statement investment is going to be on a "case by case basis… having regard to the systemic importance of the institution". The government also said it believed that in current market conditions, even fundamentally sound banks may require additional capital "to respond to widespread market perception that higher capital ratios are appropriate for the sector internationally". While no one really doubts the well-intentioned aspect of this move, given that the market mechanism itself is having difficulty at this point deciding what are and what aren't fundamentally sound banks, are funds intended to guarantee people's pensions in the future really the best source of funding for what has to be an inherently risky venture?

Friday, December 12, 2008

Why We All Need To Keep A Watchful Eye On What Is Happening In Greece


In view of Greece's EMU membership, the availability of external financing is not a concern, but the correction of cumulating indebtedness could weigh appreciably on growth going forward. While the risk of transmitting vulnerabilities to the euro area is very small reflecting Greece’s small relative size, large persistent current account deficits would increase the vulnerabilities to a reversal in market sentiment, leading to a corrective retrenchment of private sector balance-sheets in the face of rising indebtedness, and a possible appreciable rise in the cost of funding over time. These developments would have significant negative implications for growth.
Greece: 2007 Article IV Consultation - IMF Staff Report




The above quited paragraph from the IMF is a very good example of what used to be the orthodox wisdom about Greece's economic imbalances - that given EMU membership the availability of external financing should not be a concern, and that the Greek economy is effectively too small for it to constitute a menace to the stability of the eurozone itself, even on a worst case scenario. Well, if we look at the growing yield spreads you can see in the chart above (please click for better viewing) the first premiss seems to be in real danger of falling, EMU membership no longer gives an automatic guarantee of oncost-free external financing, and if you look at the names of the other countries lining up in the queue behind Greece - Italy, Spain and Portugal in particular - you can begin to see the outline of a contagion mechanism whereby the coming to reality of the worst case Greek scenario might just extend itself into a problem of sufficient magnitude to transmit Greek vulnerabilities across and into the entire euro area. No one is too small to be a problem when it comes to financial crises, and if you think I am exaggerating just look at how the "pipsqueak" Baltic economies have paved the way and opened the door to much bigger problems right across Central and Eastern Europe even as I write.

But just what are the problems Greece faces, and just what are the risks of transmission of these elsewhere?

Bank Credit Downgrades

The first of the things which has changed since the IMF wrote the staff report I cite above (back in 2007) is the soundness and stability of what was then seen as being a very well funded and liquid banking system. Only last Friday Moody's Investors Service announced they had changed the outlook on the bank financial strength ratings (BFSRs) and long-term deposit and debt ratings of four Greek banks - to negative from stable. The banks in question are National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank. This move follows decisions earlier in the week by EFG Eurobank and Piraeus Bank to participate in the Greek government's 28 billion euro (about 12% of GDP) bank bailout scheme the aim of which is to provide capital injections to the participating banks via the sale of preferred shares to the state, guarantees on debt issuance, and liquidity support. The decision by these two banks now brings to six the number of Greek banks who have decided to seek refuge in the government scheme, with the other banks being National Bank, Alpha Bank and the smaller ATEbank and Proton Bank.

Piraeus Bank has said it will hold a shareholders' meeting on January 23 to seek approval for a 370 million euro issue of preferred shares to be sold to the state. Under the terms of the bailout plan, the Greek government may spend up to 5.0 billion euros (of the 28 billion euros total, or a little over 2% of GDP) on boosting bank capital ratios via the purchase of preferred shares. These shares will pay the government a 10 percent dividend, and banks using the facility will need to accept a state representative with a right to veto dividend policy and executive pay on their boards. Banks will also have the right to buy back the preferred shares no sooner than July 1, 2009.

In addition to the evident weaknesses which have now come to light in the Greek financial system, the other worrying development we are seeing in Greece at the present time - apart that is from the largescale social conflict that has been hitting the headlines in recent weeks - is the movement in what is know as the yield spreads. These spreads are the interest rate difference a national government has to pay for borrowing money (over ten years say) when compared with that paid by the (benchmark) German government. What this means is Greek government bonds are sold cheaper (ie the government receives less for them) than their German counterparts, but their yields are higher and this is because external investors increasingly see Greece as a less creditworthy country. If Greece itself was fully self sufficient in finance (like say Japan is) then this wouldn't present a problem for bond yields (as we can see in the case of an equally indebted Japanese govenment) since domestic investors could be relied on to buy up the bonds (in a process known as "home bias"), but Greece is not self sufficient, and has to depend on external finance to fund a current account deficit of around 15% of GDP. Thus the opening up in these spreads over the last two months most now constitute the biggest headache those responsible for managing European Monetary Union have had to face since the creation of the eurozone, since according to the well know neo-classical theory of contingent convergence they should be disappearing, and not increasing.

But increasing they are, in what is only the latest example of reality defying received theory, and the Greek 10-year bond, for example, was yielding 4.89% at the close of European trading last Tuesday, while the 10-year German issue returned just 3.23%. The spread between Greek and German bonds has now more than doubled since October and indeed hit its highest level ever since the launch of the euro last Thursday - reaching 190 basis points, up from 168 before the rioting began.

These widening spreads mean more expensive bond auctions for the Greek government, and this is just where the trouble comes, since Greece has a very hefty accumulated debt to continually refinance (around 90% GDP), and it is partly because investors don't see how a government with a damaged banking system and an economy which may soon start shrinking as the recession bites can shoulder the weight of this debt, especially given the evident difficulty faced by the Greek government in enforcing measures to reduce it, that the widening is occuring.

Twin Deficit To Beat All Twin Deficits?


Basically, if I could sum all this up in a nutshell I would ask, just why are we seeing rioting out on the streets of Greece, and calm placidity down there on the Spanish highway. Well, apart from the evident differences in national cultures (which I am certainly not in any way equipped to get into) I would say there is one single fact that marks out the difference: Spanish Prime Minister Jose Luis Rodriguez Zapatero can still sign any cheque he wants to to try to fend off the worst of the Spanish crisis, while Greek Prime Minister Kostas Karamanlis no longer can. Words of warnings left unheard are now coming home to roost and the Greek government's room for fiscal manoeuvre is very very limited indeed at this point. Undoubtedly time will also run out on the Spanish Prime Minister too if we continue on the present course (as I argue in this post) but my point here is that we should be aware that events in Greece, depending on how badly things go, or how quickly they go bad, could end up cutting the available time for Spain even further, via a nasty little process which is ferquently known to go to work during financial crises: regional contagion.

We have already seen just a process at work in Eastern Europe, following the ill-advised excursion of Russia's tanks through the Roki tunnel in early August, are we now about to see something similar happen in Southern Europe following the course of the ill-gotten police bullet which ripped life and lung out of a poor young 15 year old schoolboy in Athen's Exarcheia district this week? Actually I doubt it, that is I doubt we are likely to see a similar chain reaction process just yet, but the severity of the social backdraft we have scene following the incident should serve as a warning to us all of just how delicate this situation now is, and just how easily things could be knocked off balance.

The core of the problem we have before us lies in the Greek twin defict - Greece has a very large and continuing current account defcit (around 15% of GDP, see chart below) and a very large accumulated government debt (around 90% of GDP, see second chart below).



Part of the reason for the recent surge in Greek external debt has been a rapid rise in domestic investment which was not matched by a similar increase in national saving - in fact household savings have been more or less stagnant - and this has meant that the gap between national saving and investment has been steadily growing since 2001 - increasing from 10.5% of GDP in 2001 to nearly 15% in 2006. Most of the additional gap has been due to a rise in net indebtedness by the household sector. To a large extent the decline in household saving and the increased demand for housing as a private investment vehicle can be explained by the increased access to and demand for credit in the context of financial liberalization and the lower interest rates which have followed from Greece's euro participation. Undoubtedly during the years in which Greece "enjoyed" negative real interest rates, it seem a much more attractive proposition to buy a piece of property whose price it was imagined would "never fall" rather then watch savings steadily lose their value in time deposits which were effectively being ravaged by infaltion attrition. On the other hand it is worth bearing in mind that gross Greek household debt - at a little over 40% of GDP - never reached the heady levels attained in Spain of around 90% of GDP.

In contrast, the Greek corporate sector has been running a net savings surplus throughout the entire period (and this of course is another big difference from Spain), with rising saving repeatedly exceeding investment. This notable increase in corporate saving has largely been the result of the strong profitability in the shipping and financial sectors, and it is this profitability which is now, suddenly, under threat in the current downturn.

Greek government debt, on the other hand is somewhere in the region of 90% of GDP, while the deficit is currently somewhere around 3% of GDP, but none of us (including the European statistics agency Eurostat or the EU Commission) can really be too sure of all this, since the goalposts seem to be being constantly moved in more than the football stadia down in Greece, and while it would be an exaggeration to say the data changes on a weekly basis, sometimes it seems we are not so far away from that point. Such shortcomings in Greek public finance statistics (and economic data from Greece generally I would say, if you look at all the regular omissions in the Eurostat short term data relases) are by now a reasonably well-known problem - the general government deficit for 2007 has only in the last month been revised upwards yet one more time - from 2.8% to 3.5% of GDP (much to the furor and chagrin of the EU Commission, since this put Greece in technical breach of its committments to the Commission, yet one more time), while for 2008, the official public deficit target has already been revised up by 0.75% of GDP, compared with the initial budgetary target of 1.6% of GDP, and of course with the historic record to go by and bank bailouts and the economic slowdown to think about, it hardly seems to be credible that this year will be the year, the year we finally make it back under the 3% deficit limit on a consolidated basis. The latest upward adjustment in the forecast reflects expenditure overruns of 1% of GDP and revenue shortfalls of 0.5% of GDP, although at the present time these are supposedly being partially compensated for by a series of measures implemented in September (with unknown outcome at the time of writing, but with an evident adverse impact on Greek public opinion if the images on our TV screens are anything to go by).

The September package consisted of both revenue enhancing and public consumption cutting measures with a projected budgetary impact of some 0.75% of GDP - and hence in part of course the recent furor on the Greek street. If the intended outcome were to be achieved - something which is, as I say, very unlikely under the present economic circumstances and given the government's track record - then the Greek government deficit for 2009 would be somehwere in the region of 2.5% of GDP. But the point about all this rigmorole, is that the end result of all this coming and going, and too-ing and frowing down the years is that Greece is still not completely out of its EU excess deficit procedure, and this at the end of what has been one hell of a "good times" boom, so what can we seriously expect now that the bad time have most definitely come?




Greek consolidated debt has been steadily coming down, as can be seen in the above chart (the brown line, right hand scale, please click on image for better viewing) but the problem that is facing decision makers is, will getting to grips with the heart of the financial problem imply measures which once more reverse this trend, and if it does, just how will the ratings agencies respond, and assuming we already know the answer to the last question, what will this mean for the yield spread?

Greek Economic Performance

The Greek economy has been buoyant for several years, and the gap in real per capita income between Greece and the EU–15 has narrowed significantly. Real GDP growth averaged 4.25 percent during 2000–06, and is estimated at 4 percent in 2007. Solid gains in employment and handsome real wage increases have underpinned strong consumption growth. Rapid credit expansion that followed financial sector liberalization and the drop in interest rates associated with euro adoption have fostered rising residential investment by households, while strong profitability has fueled corporate sector investment. However, the external sector has been a drag on growth; external imbalances have remained large throughout and widened.
Greece: 2007 Article IV Consultation - IMF Staff Report

Recent Greece economic performance, as measured in terms of growth in per capita income and GDP (see chart below) has been - as the IMF indicate - strong, with average annual growth running at a little over 4%, but looking at the macro imbalances which have been accumulating, we need to ask ourselves, as in the case of Spain, will there be a payback to be made for all of this good news?

If we examine the inflation chart (see below), we will find that Greek annual inflation has also been hovering around the 4% mark since the start of the century, a clear two percentage points above the ECB inflation target, and also two percentage points over the ECB policy rate during the key period from June 2003 and December 2005 (when the rate was held at 2% offering monetary conditions which were far too loose for several key members of the eurozone and in the process fuelling housing bubbles in a number of zone member states). Thus with GDP running way above what might be considered a reasonable trend level, interest rates were being adminstered at what was a real rate of minus 2%, despite the evident inflationary symptoms that there was significant "overheating" going on. Thus the Greek economy was given a pretty significant monetary stimulus during what could only have been perceived as the height boom, and at a time when the fiscal stance was also very expansionary. If any of this could work, then we would have to admit that most of what we claim to know in terms of economic theory was simply wrong - although the ECB at the point may simply have taken the IMF view that "the risk of transmitting vulnerabilities to the euro area is very small reflecting Greece’s small relative size". However since I certainly do not think that Greece is "too small to matter" and since I also think the part of our current body of economic knowledge about what you should and shouldn't do during overheating episodes is among the most tried and tested portions of our theoretical heritage,the Greek economy now seems likely to suffer from some rather severe macro problems in the course of the unwind of this particular binge, and I doubt the knock-on effects from the unwind for the rest of the eurozone will simply be too benign to notice.

We might, of course like to ask ourselves whether it wasn't a pragmatic case of "simply nothing to be done"? I would argue that there most certainly was something to be done, and it was on the fiscal side, since interest rate policy was effectively under ECB control. The Greek government, on noting the signs of overheating should have moved to a restrictive fiscal stance - in other words it should have been running a surplus, and a big one, of possibly 2% or 3% of GDP - but as we have seen, just the opposite was the case, and at the same time as monetary policy was excessively accommodative fiscal policy was busy pumping in even more juice.

And so it went on, until it simply couldn't go on any more, which is where we are now, and why Prime Minister Karamanlis cannot simply keep signing the cheques to buy social peace and satve off the downturn, although it is quite clear that this evident reality still hasn't been gotten across to Greece's two largest union federations who last week held a nationwide general strike to protest a set of government's remedial policies which, if they are anything, are already too little and too late. To give you a flavour of what is involved, here is a selection of some of the reforms that are currently causing so many problems.

The Much Needed Pension Reform

Unless the social security system is fundamentally reformed, the long-term costs of population aging are expected to threaten the sustainability of the public finances. The completion of the actuarial studies of the major pension funds has been further delayed, and the authorities are proceeding with a narrowly focused reform agenda which is nonetheless already drawing considerable protest. They have ruled out reduction of the replacement rate and increases in the contribution rates. Instead, the focus is on obtaining efficiency gains through the merger of pension funds, tightening provisions for early retirement (the list of “heavy and unhealthy” occupations and the disability pension code would be reformed toward this end), increasing the incentives for people to stay employed longer, and tackling contribution evasion. In the absence of an assessment of the cost savings, it was not clear to what extent the current reform proposals would suffice to restore the pension fund to financial viability.
Greece: 2007 Article IV Consultation - IMF Staff Report



Despite strong opposition from the main trade organisation unions, the Greek parliament last March approved a law which aimed at a long overdue overhaul of the country's ailing social security system whose longer run actuarial deficits are now estimated to be running at more than twice Greece's 240 billion euro GDP. Experts predict a collapse of the system in 15 years unless something is done to prevent this and have warned that even the current reforms may not be enough to guarantee the system. We should remember that Greece has long running low fertility (around 1.3tfr) and has a rapidly rising population median age. The working age population is soon set to start declining as a proportion of the total population. Many of Greec's working population, however, simply do not understand this rather harsh and complex reality, and are angry about being asked to increase pension contributions for what they feel may well be reduced pension entitlements later, especially at the present time as they are already feeling the pinch of the global economic downturn. The changes included merging the country's myriad 133 pension funds to form a mere 13, raising retirement ages, eliminating special and supplementary pensions, and introducing incentives to encourage people to work additional years.

Privatisations To Pay Down Some Of The Debt

Greece's New Democracy government has already auctioned stakes in Greece's largest ports in Piraeus and Thessaloniki, and sold a stake in telecoms company OTE. It has also pledged to push ahead with the privatization of several state-owned companies, such as Olympic Airways and Postal Savings Bank. Other assets to go on the auction block may include Athens International Airport. These sales have been pushed forward despite strong opposition by unions who fear job losses and wage reductions, but really - apart from the competitiveness arguments which underpin such moves - the government really have little alternative since something or other has to be sold here.

Wages and Salaries

Wage moderation and enhancing wage flexibility are important challenges. The authorities will continue with the policy of containing increases in basic wages of government employees and are hoping for a favorable signaling effect on private sector wage settlements. However, in recent years, wage increases in the private sector have been relatively large and often exceeded productivity growth.
Greece: 2007 Article IV Consultation - IMF Staff Report


One of the key areas of controversy in recent weeks has been a law which effectively ends the employees' right to collective wage contracts (Spain, be warned) and which won approval in the Greek parliament last August. The government said it wanted to clean-up debt-ridden state companies and overhaul protective employment laws in an attempt to attract more foreign investment. The Finance Minister Alogoskoufis recently told parliament the reform should be pushed ahead "for the sake of the Greek economy and society," since higher wages have added to state companies' debts, which ordinary Greeks had to cover with their taxes.

Are We A Bunch Of Hypocrites In Southern Europe?



One question I often ask myself when speaking with Spanish government employees who timidly ask me the predictable "crisis, what crisis? Can't you see, all the bars are still full!" question is just what is meant by that much used and little understood word "solidarity". We are proud to note down here in Southern Europe that we have a complex set of collective institutions which are driven by objectives of "social solidarity", not like those nasty little anglo saxon types (you know, the "neo-liberals") who live up north. But why is it, I ask myself, that I don't here this "crisis, what crisis" stuff from those working in the private sector, who spend the best part of the day at the present time looking across the factory or office floor at their colleagues and asking themselves who it is who will find themself going out of the door this week?

Solidarity means, if it means anything, that everyone shoulders some part of the burden in difficult times, and that people behave responsibily with their national resources and heritage, and accepting that when there is no money to pay for something, then there simply is no money to pay for it. If you find yourself having to depend on the stringent demands of others from outside your country, then the best thing you can do is to get your country out of the debt which is the cause of the problem, and then you can freely decide your own future for yourself. But while I can well understand how a relatively poor country like Ecuador gets itself into such a dependence-based mess, I am at a loss to understand how comparatively rich countries like Spain, Greece and Portugal have allowed things to come to the pass they have now come to, or how their citizens have let them get to the point they are at now.

One good example of the ways you get into such difficulty comes from Spain where the government now wants power companies to pay off one third of the latest tranche of a multi-billion euro deficit which has been created by utilities charging small consumers less than the cost of generation. At the present time, and following the partial deregulation of Spain's electricity sector, the government continues to set tariffs for small consumers. This deficit is estimated by the Spanish energy regulator CNE to be running at 5 billion euros for 2008 alone.
The government has no immediate plans to oblige utilities to pay for a further third of the 11.2 billion euros of tariff deficit accumulated pre 2008, since this deficit is provided for in Spansih law and appears on the companies' books as a long term credit which they are expected to eventually claw back gradually through their customers. The government has been trying to finance this deficit through quarterly debt auctions, but these have met with mixed results, and the government had to declare null and void an attempted sale of 3.85 billion euros of debt amid market turbulence in back in September. The scandalous part about all this isn't that the government could use any funds it could raise at auction for other and better purposes right now, rather it is the fact that this 5 billion euro debt which has been incurred in 2008 by selling energy to customers below cost has only been adding to the hole in the current account deficit, since the energy it pays for effectively needs to be imported.

One key feature in all this woe has to be a political process that is extremely ineffective, and driven by the fact that no one likes to hear bad news, and that the last thing a politician is able to say is tighten-up your belts now lads and lasses, we are in for a rough ride. But isn't this just how the IMF gets such a bad name for itself, since the IMF doctors get called in just where the domestic political process breaks down, and where local politicians haven't the ability to stand up in front of their citizens and say, it's going to have to be like this, I'm afraid. Isn't this what just happened in Ukraine, Hungary and Latvia? And then people say, those "nasty folk" at the IMF, they cut pensions everywhere they go, and wages are down 8% in Hungary, and 15% in Latvia once the IMF get to run the show. That is the IMF make for a convenient scapegoat, but people seldom ask themselves why wages needed reducing, or why there is no money to pay the pensions. Oh, I know.................

The Greek Economy Is Slowing Rapidly

Greek economic growth is now slowing rapidly. Quarter on quarter growth in Q3 2008 was 0.4%, and almost all the growth the economy has been getting this year (including that sharp spike you can see in Q2 in the chart below) comes from earnings from shipping services, earnings which are now falling dramatically as global trade starts to contract. The economy is expected to decelerate further in Q4, and may even contract slightly, with a best case scenario of remaining around the stationary level. Thus the Greek economy should start contracting - and thus formally enter recession in Q1 2009, at the latest.



Given the difficulties Greek banks are having in raising finance in the global financial and capital markets, the ensuing tightening credit conditions are bound to lead to a further slowdown in private consumption. Government consumption is expected to move more or less in line with GDP, while public investment is expected to rebound in 2009, largely reflecting an accelerating pace in the implementation of EU Structural Funds. Household borrowing has - as we have noted - increased at a rapid rate between 2003 and 2007, but during 2008 the rate of increase has been slowing steadily (see chart below).

This reality is reflected in the recent statement by central bank govenor George Provopoulos that he hoped the bank bailout plan would be able to keep the country's credit expansion pace at 10 percent next year (down from around 18.1 percent currently). Even were this to be achieved (which is far from clear), as we have seen in Spain it will lead to a sharp contraction in an economy which had grown accustomed to new credit generation at twice that rate, and especially given the governments inability to step in and offer any fiscal support.



In addition, the Greek construction sector - which, it should be noted, never became so bloated as a share of GDP as it did in Spain and Ireland (where it hit around 11%) - has now been slowing since Q3 2007, when it hit around 7.5% of GDP, and was down to 5.4% in Q3 2008, and was dropping year on year at an annual 6.7% rate in September 2008 according to the latest data from the national statistics office.

Industrial output is also now falling, by 4.5% in October, and the November manufacturing PMI registered a series low of 42.3 indicating even faster contractions in the pipeline. Greek industry has been getting some uplift from the economic boom in South Eastern Europe, and since that is now well and truly over, we should expect the manufacturing downturn to be sharp and sustained.


In the shipping sector, a significant jump in world freight rates and a rise in shipping volumes on the back of a hefty increase in world demand for oil and other minerals both boosted the sector’s profitability, and increased it's importance in GDP growth (indeed growth in the last couple of quarters has been virtually all about shipping). This favourable position has now very much turned. George Economou, Greek shipping billionaire and Chairman and CEO of DryShips recently characterized the current collpase in the Baltic Dry Index (of bulk charter cargo rates) as something like "a nuclear explosion" for those in the shipping industry. The index, which measures world shipping charges for raw materials, has plummeted from a high of 11,793 in May to 672 (see chart below), its lowest level since soon after the index was established, back in 1985. Daily-rental rates for the largest Capesize category of carrier have plunged from $234,000 just two months ago to $2,320, a fall of a staggering 99%.



Even more worrying for the mid-term outlook is the rush to cancel orders of new ships. In November, New York–based Genco Shipping and Trading willingly agreed to say adios to a $53 million deposit simply to get out of a half-a-billion-dollar deal to buy six new vessels. Clarkson Plc, the world's largest shipbroker, announced that while 378 ships were ordered during October 2007, only 37 were ordered in October 2008. And back in Greece Kriton Lendoudis, managing director of Athens-based Evalend Shipping Co., estiamets that in Greece there are currently some 100 applications by shipowners to lay up their vessels. Lendoudis concludes, "The next 24 months do not look very optimistic." It's hard to disagree.

So my feeling is that - taking all the above elements into account - we should expect Greek economic performance to deteriorate at a rate and to an extent which may surprise the casual observer of economic events. Those who have already been following closely what has happened in countries like Spain, Latvia and Romania should, however, be fully prepared for what is now to come. The first signs are there, in the EU confidence chart I close with (below). As can be observed, a slow and steady deterioration has suddenly, after the summer, changed course, and become a sharp downturn. I fully expect that we will now see this general shift in confidence find its reflection in the real economy data that comes rolling in over the next three or four months.

Thursday, December 11, 2008

So Just When Does Spain's Twin Deficit Problem Become Unsustainable?

This, it seems, is the question of the day. According to the IMF Spain’s economy faces a contraction of at least one percent next year. And the IMF stress that the risks to this forecast “remain on the downside” since the country’s real-estate market is “in full correction,”. Also, horror of horrors (and we will return to this). The government’s budget deficit will exceed five percent of gross domestic product next year, the Fund forecast.

While the IMF seem to be more aware of the scale of the problem than the Spanish government currently are, they do seem to be putting all of the emphasis for recovery on some much needed labour market reforms, but personally I don't think even these are playing in the right ball park, we need a big picture "breakout" escape plan, to cut loose from the pincers of cash drought, corporate bankruptcy, construction dependency, large scale contraction and price deflation. It's a big mess, and will need an equally bold and ambitious plan to get to grips with it.

One point which is obvious at this stage is the Spanish government forecasting - where they have built a 1% expansion into the 2009 budget - is getting ever more out of line with the economic dynamic. Really this is the first thing which has to change. Spain urgently needs someone leading the country who is able to turn the page, put some realistic numbers on the table, and try to work to meet objectives, instead of simply failing to achieve them time after time. What do I mean by this, well, if you seriously think that the contraction next year will be of 2% of GDP then it is better to say 3%, and beat your target, that say 1% growth and come in with a 2% contraction. Not only will your citizens be getting more and more fed up with all of this (and the impact on morale should not be treated lightly) but much more to the point, since Spain is heavily dependent on foreign finance to buy the debt that the government is going to need to issue (see more below) to finance the fiscal deficit, then each and every failure to achieve target is likely to be punished with a higher cost of financing debt (as the yield spread on the risk rises). So as well as the credibility cost, this kind of playing fast and loose with the forecast is now likely to carry a real financial cost.

Of course, in true wooden bureaucrat style (where are we here, back in the old USSR?) a spokeswoman who declined to be named in line with ministry policy informed Bloomberg that while the Finance Ministry shares the IMF’s analysis of the economic situation, it doesn’t back the specific IMF forecasts on growth and the budget deficit. Obviously the spokeswoman not only decline to be named, she also decline to enter the Byzantine discussion of how it is possible to share the analysis without sharing the conclusions. The man who is hotly rumoured to be pencilled in as Pedro Solbes successor in the next facelift, Economy Secretary David Vegara was rather more elegant when questioned about the estimate by reporters "To me it's reasonable, I always think the IMF and OECD do their work with first class technical groups,". Exactly, although of course, in the forecasting game even the best of technical teams can get it wrong, which is what the IMF allow for when they talk about "downside risk".

Vergara was also of interest yesterday insofar as he specifically denied that Spain faced a deflation problem, although he did admit that inflation was likely to reach a very low level. I think, yet one more time, this is "ostrichism" (avestruzeria), since the drop in prices is now so evident, and the contraction in Spain is going to be so sharp, that Spain has to be the one developed economy where price deflation is now a near certainty, and you can quote me on that. As I go to my local bar for the morning coffee, I always take a look to see whether the 1.15 euros they currently charge for a cafe con leche has been brought down to 1.10 euros. Not yet of course, but when will that happen? In March? In June? I bet it happens before August next year (and I will report). And when it goes down to 1.10 euros, the next move will be 1.05 euros, and so on..... depending on just how long the deflation continues.

So Just How Much Will The Spanish Economy Contract In 2009?

Well, I think this is a very hard question to answer. I think a 1% contraction is a done deal, and my own previous best guess was in the 3% to 5% contraction range, which is, of course, very strong indeed. And there I was happy to leave it, until that is Deutsche Bank came out with their latest 2009 forecast for the German economy, where chief economist Norbert Walter has said that Germany's gross domestic product could contract by as much as 4 percent next year. This has to be "bottom of the range" estimate, but then, it might happen, I mean these are not just numbers spun out of thin air, they are backed by analysis, German manufacturing is contracting very rapidly at the moment (but not as rapidly as Spanish manufacturing). The German government itself is forecasting a 1% contraction, and the IFO institute came out today with 2.2% contraction estimate for 2009 (the median forecast?). At this point I won't go so far as to modify my original forecast, but what I will say is that if German GDP contracts by 4% in 2009, then Spain's will contract in the 5% to 7% range, since on every important reading Spain is contracting moer rapidly than Germany at this point.

But what About The Sovereign Debt? What Is Going On With All That Government Spending?

This I think is the big point.

At the risk of boring to tears all my regular readers I would first like to stress that what we have in Spain is not a simple garden-variety housing correction. Spain is a country which was allowed across the 2000-2007 period to develop massive macroeconomic imbalances, which to some extent were reflected in a huge housing boom. But the imbalances (current account deficit of 10% of GDP, massive migrant flows - 5 million people in 8 years, rapidly rising household and corporate debt - rising at 20% pa, and reaching around 90% and 120% of GDP in 2008 respectively) and not the housing are the key to the problem. Thus Spain's economy is not reeling under the weight of the unwinding of the property boom, but rather Spain's property boom is reeling under the impact of the unwinding of the macro imbalances, and this unwinding became more or less inevitable once the US sub prime crisis broke out in August 2007. I think it is no accident that the two countries who noticed most the shell shock from the sub prime turmoil were Spain and Kazakhstan, since these two countries were the most dependent on selling some type of paper or other in the wholsale money markets to finance their imbalances, and the doors to these markets effectively closed in September 2007.

So what we need to think about is the impact of the problems Spain's financial system is having (due to difficulties in financing the current account deficit) on the housing bubble and the construction industry, since this I think is the way the causal arrow works in this case, and not the other way round. And it has been the failure to appreciate this causal chain, in my opinion, that has lead so many people to have had so much difficulty understanding the extent of the problem we have here in Spain.

Basically the housing boom had masked the enormous problem Spain had acculumlated in terms of its current account deficit, for the simple reason the funds which were happily flowing in to fuel the boom meant the books balanced easily enough each and every month. But once people became just a little bit nervous about what was happening to that boom, and how sustainable it was, the flow of funds suddenly dried up, just like that, in September 2007, and the size of the hole in the flagship side suddenly became apparent. Since that time the bilge pumps have been busily trying to drain all the water which has been flowing in, but alas without notable success.

When I say the bilge pumps have been working, I am talking about attempts by the ECB and others to provide liquidity to the Spanish banking system, but if we look at what has been happening to lending in Spain in recent months, we will see that this particular cocktail still isn't managing to reach the parts "the other beers cannot reach". Below we have a chart (based on Bank of Spain data) which shows net additional lending to households on a monthly basis.



What is clear from a quick glance is that lending since June has been virtually stationary, which means basically new funding is being provided for mortgages only at the same rate as old ones are paid up. This effectively means that if something can't be paid for in cash or with a credit card, then it really isn't being sold, and every time less so. To get things in perspective, new lending to households was running at the rate of about 10 billion euros a month up to the summer of 2007. It also means that a business sector which had become accustomed to having new business at the rate of 10 billion euros a month has no found itself with virtually nothing (as I say, simply the business you can do on the basis of recycling the old credits which are being paid off).

But there is new money every month, the CA deficit (which is reducing) is being squared, so where is the new money going. Well that's easy isn't it, to the government to finance the growing deficit, and to Spain's corporates, who need to keep refinancing all that debt, debt which is only mounting, of course, becuase no one has money to buy the products they want to see, and why don't they have money? Because the money needs to go to keep the companies afloat, or to fund government rescue plans, to help the firms (possibly via the banks) who can't sell becuse the customers don't have money to buy. Oh, I see.

Of course the solution to this macarbre vicious circle is not to lend the money to the customers who are in any event far to deep in debt, but to reduce the current account deficit which lies at the heart of the problem, possibly by encouraging some people abroad to borrow a bit more money, and then selling them something they need, at a price they may be interested in. It's called "export".

In fact Spanish corporates received a net 19 billion in additional lending over the three month July-September (while households received a net 800 million) but as we can see, all this extra debt isn't moving us forwards very fast, and indeed we are actually going backwards.



As I say, Spain's big problem is the current account deficit, which reached 10% of GDP last year (see chart above). At the present time this deficit is dropping slightly as imports collapse, but it is not falling as fast as it should be, and meantime, as I am saying, the Spanish government is raising its borrowing needs. Spain has movied in 2008 from havin a 2% of GDP surplus in January to a 3% deficit in December (ie a shift of 5% of GDP), in 2009 we will move up to at least 5% (as the IMF suggest, and we could even move higher depending on what happens to GDP).


The fiscal response has been swift and large. The government has taken 4 percent of GDP in structural measures for 2008-09 to assist the economy-bigger than many EU partners and ahead in timing. Together with automatic stabilizers, this results in deficits of 3 percent of GDP in 2008 and over 5 percent in 2009-a swing of more than 7 percent of GDP in the headline balance (compared with an end-November 2008 estimate of 1¾ percent for the euro area as a whole). While the mission notes the focus in the 2009 package on spending for labor-intensive local public works, the authorities need to ensure that this is channeled to its most productive use. The mission sees this fiscal effort (with built-in unwinding as the exit strategy) as temporarily boosting demand.
IMF Article IV Consultation: December 2008


So in 2010 we could find ourselves with a CA deficit of around 8% of GDP and a government fiscal deficit rising up into the 5% to 7% region. If this does prove to be the case, then I think the financial markets are absolutely going to see red (there are already problems with the eurozone sovereign 10 year bond spreads, see the charts below) and Spain could find itself just where Hungary was in 2006.




As ECB Council Member Jürgen Stark said in an article in yesterday's Wall Street Journal, the environment for conducting economic policies, and in particular monetary and fiscal policies, has now become extremely "challenging". One part of this challenge is going to be the funding of all the extra borrowing that euro-area governments will need to do to make good on all their promised support for the banking system, most notably the funds for recapitalization and guarantees for interbank loans. Stark estimate that to date, the envelope of funds for possible recapitalizations and guarantees amounts to some €2 trillion, or roughly 20% of euro-area GDP. This is a very large number.


As Stark also notes many euro-area governments failed to use the past boom times to consolidate their public finances (although this was not especially the Spanish case). As a consequence, many euro zone governments are now entering the current downturn with high deficit and debt ratios. Given the weak growth ahead and the costs of the bank bailouts, these ratios are inevitably set to rise. Stark estimates that in a year's time the deficits in many euro-area countries will be between 5% and 7%, up from around 3% now, while public debt may rise by 10 to 20 percentage points. Again these numbers are very large, and financing them is going to be, as Stark would say "challenging".

As can be seen from the chart above, interest-rate spreads for government bonds are already high (and rising) in a number euro-area countries, and I would draw special attention here to the cases of Greece and Italy, since they have been constantly warned about the danger of this kind of development. And governments are having growing difficulty selling paper, as both the Netherlands and Austria found out this week. The Dutch government failed to raise as much as it had targeted for three bonds - maturing over five, six and seven years, respectively - while the Austrian government saw one of the weakest auctions in years for 12-year paper. These difficulties highlight the potential problems that may be faced with the vast
pipeline of government and government-backed debt following the announcements of big fiscal packages to stimulate economies and bail out banks.


And analysts are warning that while the problem isn't a big one right now, these early signs of stress, following so closely on the back of the announcement of big fiscal stimulus programmes, are a clear warning of potential problems next year when record volumes of debt are due to be issued. More than $1,000bn of government debt is expected to be raised in Europe in 2009, while close to $2,000bn is forecast in the US.



The Austrian government found itself forced to pay 13 basis points more than comparable 12-year bonds for its €1.1bn issue, while the Dutch government only managed to raise a total of €2.46bn for the three bonds being sold after indicating that it wanted between €2.5bn and €3.5bn. Since the Netherlands is normally considered one of the strongest and safest of credits,then frankly this does not augur well.

The thing is, Spain's downturn is now pushing the country's former fiscal rectitude into the distant past of historical memory. Worse, the debt is being levered up, not to buy a piece of the future for a country in the process of a thoroughgoing renewal, but rather to keep one group of already moribund and walking dead corporates alive, just as long as it remains possible to keep selling Spanish Sovereign debt at prices which don't swallow up most government revenue simply paying off the debt. But as those spreads move skywards that point will be reached, most probably in 2011. By which time Spain will be perfectly poised for one of those classic twin deficit national-bankruptcy scenarious financial crisis theorists like to write so much about.

Short-run fiscal policies need to be embedded in a long-run context to explain how the debt can be lowered once the economy stabilizes. Public debt, while still manageable, is poised to jump. To boost confidence in light of high aging costs, the authorities should present a plan how to lower the debt again once activity stabilizes, including with pension reform. The mission encourages the authorities to develop an intertemporal public sector balance sheet for publication in the annual budget. It would show the debt already incurred, and also the present value of the projected stream of future deficits (a forward-looking debt) under unchanged policies. This provides perspective on long-run fiscal sustainability.
IMF Article IV Consultation: December 2008



Keynes once recommended paying people to dig holes in the ground and fill them in again rather than leaving them languishing on the dole. The Spanish government seem to have gone one stage further, they are only paying us to dig the hole, there is no plan to fill it in again, unless that is they have a prepaid contract with Komatsu or Caterpillar to come over (in the eventuality this is needed, which it will be) with some earth moving equipment, and shove the soil back in to bury the lot of us.


Appendix

These are just a few additional charts to supplement some points being made in comments.

First of all bank lending to households (in billion euros), the chart I have in the post simply shows month on month net changes, this one shows how the total being lent has slowly become more or less stationary.



This compares to some extent with corporate lending, which has been growing even in the most recent months.



So lending is up year on year in both cases, to private households by 54 billion euros (or about 5% of GDP), while lending to corporates is up by 98 billion euros (or nearly 10% of GDP), while GDP growth has been very very limited.

As far as comparing Spain with Germany goes, here are both the manufacturing PMI charts. It is clear that in each month Spanish industry is contracting more rapidly than German industry.





Now the point could be made that Germany is more dependent on manufacturing industry than Spain. So lets look at services, and again we get the same picture.






I don't think it is necessary to present any charts for construction, since I imagine that everyone realises that Spanish construction is contracting more rapidly than German construction at this point in time. So basically, I am pretty confident that whatever contraction the German economy registers in 2009, the Spanish economy will register a greater one, and this for even one more reason, and that is that the shortgae of new credit and purchasing power in the Spanish economy means that it is now an export dependent economy, and one of the important potential customers for Spanish exports, but as the Chinese and the Japanese and even the Germans themselves are discovering at the moment, if you are export dependent and your customers go down, then down you go too, and possibly even more so.

In A Xmas Shopping Spree Italy's Enel May Buy-up Endesa

Well if you want to know what this is all about you really need to read this post on Lukoil, Repsol and Sacyr where I spell out why it is Acciona needs to sell in such a hurry. Still, I didn't expect this to happen so quickly, yet the Italian daily Il Sole 24 Ore are reporting today that Enel SpA may buy the rest of Endesa before Christmas by purchasing Acciona’s 25 percent stake. Acciona has a put option to sell Enel its stake in Endesa from March 2010 at a price of 42 euros a share, although the two companies have been negotiating to bring forward an agreement.

Reyal Urbis Pressed To Raise 143 Million Euros


The chairman of Spanish building firm Reyal Urbis said yesterday (Wednesday) he had won a two-day extension on a 143 million euro debt owed to fellow shareholder Corporacion Financiera Issos. This whole situation seems to be a very tangled web of interlocked shgareholdings and intrigue, and perhaps the strangest part of the situation for the external observer is the fact that Reyal reecntly reached a deal with creditors to refinance its principal 3.006 billion euro debt in October, and it seems weird that they are now twiddling around with a mere 143 million. Almost 60 percent of Real assets are, however, tied up in what are now very hard-to-sell plots of land.

The background is that Rafael Santamaria, Real's chairman and majority shareholder, last year signed an option under which Issos could sell its 4.9 percent stake in Reyal Urbis back to the company for 10 euros a share or 143 million euros. This option was due to expire yesterday (Wednesday).

Reyal shares closed at 6.05 euros on Wednesday compared to 10.80 euros in June 2007 after Reyal bought Urbis in one of the biggest deals in Spain's then-thriving property sector. Issos is the private investment vehicle of Spanish businessman Jose Ramon Carabante.

Santamaria may hope to get the money he owes Issos from fellow developer Nozar. The unlisted firm also had until the end of Wednesday to pay Reyal Urbis 205 million euros it used to buy 5 percent of Colonial a firm with 10 billion euros of debt whose share price has collapsed this year. Obviously this is all very cliff hanging, and a short term solution may well be found. Spanish media have speculated the Nozaleda family may try to pay the debt in assets rather than cash, but then stumping up assets in this environment is almost like not paying, since what people need is cash.

In an indication of how all this can unwind quite badly under the domino effect weight of one seemingly fortuitous event another investor, Global Cartera de Valores, was also due to pay Reyal a 70 million euro debt by Wednesday night but last Friday Global Cartera filed for administration - a move which was dircetly related to its Reyal debt, according to Spanish newspapers. So basically, if they aren't carefully, a "mere" 143 million shortfall (remember Martinasa and the "anticipoated" ICO loan that never appeared) can simply unwind a carefully designed 3 billion euro, just like that loose thread I am looking at on my pullover can unravel the whole jersey spoon, if I don't do something. Darn it!


Hotel Prices Fall 8% in Q3

On the deflation alert anecdotal gossip front, the price of Spanish hotel rooms fell 8 percent this summer versus the same period 12 months earlier, according to online booking portal Hotels.com yesterday (Wednesday). Hotels.com, which claims to be the most visited online hotel booking website in the world, added that from July to September prices on Ibiza were down 36 percent from a year ago and in Malaga by 21 percent.

The average price for one night in a Spanish hotel stood at around 100 euros in the third quarter compared to 128 euros in the UK - a 13 percent fall year on year, it said. Britain and Ireland were the only European countries where hoteliers cut prices at a faster rate, but the effect is likely to be more marked in Spain since it is the world's second most visited destination and tourism accounts for some 11 percent of GDP.

House Prices Down 7.8% Y-o-Y In November

My feeling is that 2009 will be the year when realism finally arrives in the Spanish discourse about the current crisis. I think this for all sorts of reasons which I will attempt to explain in posts to come, but I think as we approach that point some of the data sources will become rather more reliable, and some of the forecasts rather more realistic.

A good example of this process is TINSA, Spain's leading property valuation company. According to their latest monthly Spanish house price index Spanish property prices fell by 7.8% over 12 months to the end of the November. The Tinsa index may not be perfect, but it is probably the best thing we have (as they say) and certainly a lot more realistic than the rather notorious Spanish Housing Ministry index. What this means is that Spanish house prices are now back to where they were between May and June of 2006, although this is certainly not very big beer yet, since arguably Spanish property prices were already hugely overvalued in the summer of 2006, and not that many people have mortgages of (LtV) 100% of the purchase value post summer 2006 - which is the real measure of bank landing risk as prices drop back. Still, this does now give us a yardstick to work from, and we will be able to follow this index back up river through the months, as property prices fall and fall.


Accounting Irregularities At Martinsa Fadesa


Naturally, a lot of the details behind what we are seeing on the surface at the moment will only become clear later, as events take their course. Some indication of what may be in store for us comes to light in the recent report of the court-appointed administrators handling Martinsa-Fadesa’s insolvency (as covered in the Spanish press). One example would be the plot of land in Guanarteme (Las Palmas, The Canaries) which belonged to Fadesa, and valued at 1 million Euros, and which was subsequently revalude at 170 million Euros following Martinsa's take over of Fadesa during the creation of Martinsa-Fadesa. Another plot of land in Culleredo (Galicia) was revalued from 1.5 million Euros to 84 million Euros, and the property in Puerto Real (Cadiz, Costa de la Luz, Andalucia), which went from 336,000 Euros to 65 million Euros, an increase of 19,000%. All these revaluations helped inflate the value of the assets on Martinsa-Fadesa’s books and allowed Martinsa-Fadesa to book a profit in 2007, and refinance its growing debt, despite its rapidly deteriorating financial situation.

Martinsa-Fadesa able to make these spectacular revaluations thanks to the tireless work of leading property appraisal companies like Tasamadrid (owned by Caja Madrid, one of Martinsa-Fadesa’s biggest creditors), and Ernst & Young, an accounting firm that approved the revaluations in its audit. The administrators’ report values Martinsa-Fadesa’s assets at 7.34 billion Euros, 32% less than a previous valuation by CB Richard Ellis, which doesn't mean, of course, that even this much more realistic current valuation will be what they will eventually be sold for. Far from it probably. Methinks that below all that concrete and cement lies a very large can of worms which has yet to emerge. The patience of Job is what we are all going to need here, and all will out eventually. And of course, the growing army of Spanish unemployed will have all the time in the world on their hands, just to watch and wait.


Brisk Demand For Funds At Spain's Second "Reverse Auction"

Demand for funds more than doubled at Spain's second auction to buy financial sector debt today (Thursday) as liquidity-starved banks seemed to shrug off the stigma of seeking government aid during the credit crisis. Spain's biggest banks Santander and BBVA did not take part but 37 smaller institutions did. As a result the Spanish government bought 7.2 billion euros in mortgage-backed debt from 31 banks at the auction, 91 percent of a maximum 7.9 billion euros, after receiving 9.65 billion euros in bids, according to the Economy Ministry statement.At the first auction on November 20 Spain bought 2.1 billion euros in debt from 23 banks, or 42 percent of a 5 billion euro ceiling, after 4.6 billion euros in offers. So they have now bought a total of 9.3 billion euros. Spain's Fund for Acquiring Financial Assets was estabilshed as part of the rescue programme to provide an alternative market for banks to issue long-term debt. Most institutions taking part were savings banks that are thought to have a high exposure to the property sector and are experiencing greater difficulty raising funds on the open market. Under the current plan Spain is pledged to buy up to 50 billion euros in bank assets, and guarantee around 200 billion euros in bank debt issuance, to prevent capital shortages in its financial sector and boost private sector lending. This scheme may well of course be expanded.

Wednesday, December 03, 2008

Spain's Services Sector Continues To Take a Pounding In November

Well the news from Spain at the moment never ceases to surprise on the downside, with this months Services PMI reading giving us just the latest example. According to the the November survey activity, new orders and employment all hit new lows and some firms are now starting to accept that the economic slowdown will stretch into 2010 at least. The Markit PMI, covering Spanish service companies ranging from hotels to insurance brokers, dropped to 28.2 in November from 32.2 in October, showing the sharpest monthly contraction since data was first collected in 1999. It goes without saying that the figure is way, way below the "neutral" 50 level which separates growth from contraction.







"The latest PMI data are very, very bad with falls in output, new orders and employment at an extent which would have been unthinkable just one year ago," said economist at Markit Economics Andrew Harker.



The services data mirrors the equally dismal figures from Spain's manufacturing sector which I reported on on Monday, which also hit record lows in November.

With consumer confidence sliding, unemployment soaring and business conditions worsening by the day, expectations continued to be pessimistic with some surveyed going so far as to suggest they thought the economic downturn would last into 2010.

The rather later deterioration of Spain's services sector (when compared with the more longstanding contraction in the industrial sector - see yesterday's post) is also reflected in the quarterly services index published by the INE with the national accounts. Spain's services obviously hung out rather longer than the manufacturing sector, but now this too - in its turn is folding, which means on the provider side we now have all major sectors - industry, services and construction in sharp slowdown. It no longer makes any sense at all to talk about this as a "housing slowdown" - really it never was, since it has always been a financial crisis (or at least since the summer of 2007 it has), with construction just being the first sector to get hit really hard, since without mortgages you can't sell houses, and now we are discovering that without loans you can't sell cars etc, etc.


Accelerating Slowdown After The Summer

Thus while the PMI headline index has now shown business activity among service providers shrinking continuously since last January, the pace of decline has accelerated significantly over the last three months. Both new business and employment contracted at the steepest rate in the series history in November. Companies have now been cutting jobs every month since March.

Also, for those who are following the deflation argument, it is worth noting that service providers cut their charges during the month at the fastest pace recorded by the survey, as the attempted to compete for what is now increasingly scarce new business, while energy costs and other input prices continued to rise, squeezing profits. Meanhwile Joaquim Almunia said today that deflation is not a real risk in the euro zone. Of course, in one sense this can be quite intentional splitting hairs, since while the deflation threat in the whole zone may not be that great (although we do need to wait and see on what happens in Germany here), in countries like Spain and Italy it is becoming an increasingly pressing issue.

Also interesting was the reason why he felt deflation was unlikely:

"We have different conditions than in other countries. We have a labour market that is organised in such a way that makes it extremely, extremely difficult to go towards deflation."

This seems to be saying that we won't be talking about labour market reform as one of the tools in confronting the crisis, and hence, as demand for their products contracts, we will simply sit back with folded arms and let them close, one by one, rather than adopt any kind of aggressive policy to bring back competitiveness. If this is what he has in mind, then this kind of "quietism" is surely a serious error, and anyway (do correct me if I am wrong) but isn't he being paid at this point to promote the Lisbon strategy (labour market reforms and all) as one pillar of our response to the crisis?



Another Shoe To Drop?

My feeling is basically that there is another shoe to drop here. Some of the PMI respondents seemed to accept that Spain's contraction would now almost certainly last on well into 2010, but others continued to express hope that the crisis would prove to be a short-lived one, and expectations for business in 12 month' time bounced back a bit from October's survey low (although we should note that the response remained pessimistic overall). This also seems to mirror a response from Spanish consumers (as covered in my last post) that things would start to get better in the middle of 2009 (my guess is that the really serious part will only be hitting us by then, and maybe not even until later, depending on when builders and property companies go bust big time), but the view is getting support from the insistence by the Spanish government that the Spanish economy should begin to register growth from mid-2009. Joaquim Almunia also reflects this view:

"I hope we will adopt decisions using the fiscal stimulus, using monetary policy ... to avoid a protracted recession and to prepare the economy for a recovery that I hope will come in the next quarters, hopefully in the second part of 2009,"


This view is hopelessly optimistic and superficial, and I do therefore worry about what will in fact happen to business and consumer confidence when it becomes plain that this much hoped for recovery simply isn't going to come. We built the station, but someone unfortunately laid the rail tracks to pass through another town.