5 reasons for Spain's colossal economic troubles

Repeated efforts since 2009 by successive governments to fix the country

Protesters demonstrate against the country's near 25 percent unemployment rate and stinging austerity measures introduced by the government, in Madrid, Spain, Saturday, July 21, 2012. (AP Photo/Andres Kudacki)

MADRID (AP) — Spain's financial crisis is a lot like peeling an onion: remove one troubled layer and you only expose another.

Repeated efforts since 2009 by successive governments to fix the country's problems have only managed to undermine confidence in the fourth-largest economy among the 17 nations that use the euro.

A recession is deepening in Spain and the growing number of its regional governments seeking financial lifelines is only adding to the problems of a government already struggling to prop up its shaky banking system.

Spain's main IBEX stock has lost 3 percent over the last three days while the government's borrowing costs for its debt have soared to their highest levels since the country joined the euro in 1999.

Last Friday, Spain finally got approval from the eurozone to use a €100 billion ($121 billion) lifeline to prop up its banks weighed down with toxic assets from an unprecedented property boom that imploded.

Spanish officials had hoped a solution for the banks would prompt investors to stop demanding unmanageably high interest rates for government debt. Such high rates forced Greece, Ireland and Portugal to seek full-blown public finance bailouts.

But instead of easing off, investors panicked again.

On Monday the country's central bank said that the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won't return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as a growing number of regional governments that function like U.S. states ask federal authorities for assistance.

By Tuesday, investors had sent benchmark borrowing rate for Spain's 10-year bonds to 7.54 percent, just the latest in a series of records. By contrast, Germany's is just 1.26 percent.

If Spain's borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue that would push Europe's rescue funds to breaking point.

Here are five reasons investors are scared about Spain:

HURTING REGIONAL GOVERNMENTS

During Spain's property boom, the country's 17 semi-autonomous regions raked in unprecedented revenue from building permits and fees. They used the money on a spending spree — hiring public servants who can't be fired and racking up debts on massive white elephant infrastructure projects. Across Spain, highways, parks, public swimming pools, gleaming government buildings and airports sprung up.

Now the property market has collapsed and the country is in recession, regions can no longer afford to pay their bills and manage their debts.

The regions' problems have been a focus of investor concern for more than a year, but the fears skyrocketed last Friday when the region of Valencia announced it would be the first to tap a federal fund set up to finance the hurting regions. Then over the weekend, the region of Murcia said it also needed help.

More regions are expected to join the queue, threatening to overwhelm the central government. No one knows how much money the regions will need, though leading newspaper El Pais said they have debts of €140 billion and that €36 billion must be refinanced this year.

The fund set up by the government on July 13 will have €18 billion in capital, part of it raided from national lottery coffers. So if more funds are needed, Spain would either have to issue debt at punishing rates — or ask for a bailout.

WEAK GROWTH PROSPECTS

While one out of every four Spaniards are unemployed, the rate for job-seekers under 25 stands at 52 percent. Emigration by young adults is on the rise, and companies are taking advantage of new labor reforms that make it cheaper to fire workers. The country is in its second recession in three years.

Just as Valencia was announcing its financing needs last Friday, Spain's finance minister revealed that the economic contraction will be deeper than expected in 2013 — meaning an even longer period of economic pain before Spain can hope to start generating jobs again.

Instead of economic growth of 0.2 percent next year, the government now forecasts a contraction of 0.5 percent. For this year, it expects a smaller contraction of 1.5 percent, compared with 1.7 percent previously.

BANK BAILOUT WORRIES

The concerns circling Spain's shaky banks intensified in May when Bankia, the country's fifth-largest lender, unexpectedly announced it would need €19 billion to clean up its balance sheet. A month later, leaders of the other 16 countries that use the euro crafted a rescue package of up to €100 billion for Spain's hurting banks.

Spain still hasn't put a precise figure on how much the banks will need, denying investors a clear picture of the extent of the problem and whether the €100 billion is enough to handle it. Those numbers won't start coming out until September when extensive audits and stress tests of each bank are finalized.

Spain resisted for months the idea of creating a "bad bank" to absorb the toxic assets and sell them off, but buckled under the pressure of demands by eurozone leaders to do just that.

Friday's announcement by eurozone finance ministers that they had agreed the terms of the bailout hasn't quelled markets as the government is ultimately liable to repay the money. It had been hoped that responsibility for repayments would shift from the government to the banks. But that shift is a long way off — a pan-European banking authority would have to be created first and that could take years.

DEBT DEPENDENCY

The bank bailout has only made investors more worried about Spain's financial position.

Two-thirds of Spain's government bonds are held by the country's banks, pension funds and insurance companies — that's 50 percent up from last year. This sharp increase is a sure sign that foreign demand for Spanish debt is falling fast.

Spain has so far this year issued €59 billion in bonds out of a total €86 billion planned for 2012. As Spain tries to issue the rest of that debt to fund itself, who's going to buy it?

Market-watchers are concerned that Spain and its banks are dependent on each other: the government is issuing debt, the majority of which is being bought by its banks, only to use the funds from the sale to prop up its banks so that they can buy more government debt.

GROWING PUBLIC ANGER

Since beating former Socialist Prime Minister Jose Luis Rodriguez Zapatero in the polls late last year, Prime Minister Mariano Rajoy has been introducing successive rounds of austerity measures aimed at preventing the country from being forced into a public finance bailout.

Rajoy's latest set of measures has been his most controversial —a steep hike in Spain's sales tax, and the elimination of one of the 14 yearly paychecks that public servants receive.

Spain has been spared the level of brutal anti-austerity street violence like that seen in Greece, but got a taste of it on July 11 after Rajoy unveiled the new round of cuts and tax rises. Spanish miners and sympathizers, incensed with the seemingly endless cutbacks and tax hikes, clashed with riot police who fired rubber bullets, injuring 22 demonstrators and 10 officers.

The miners said cuts in government mining subsidies will leave them jobless, and many Madrid residents joined in because they believe the problems that the miners face are similar to their economic woes.

Off-duty police and firefighters are starting to join in anti-austerity protests by public servants. Officers are prohibited from wearing their uniforms while protesting, but deck themselves out in white shirts to identify themselves, and the firefighters hold their helmets.

If future protests come with escalating violence, that would only make investors more nervous about Spain.
Associated Press
Copyright 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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