Spain self-deluding

In a manner disturbingly all too reminiscent of Greece earlier this year, the Spanish authorities appear to have deluded themselves into believing that the Spanish economy is about to rebound and that Spain can muddle through without an IMF-European Union bail-out package.

Denial is also all too much in evidence with respect to the Spanish banks. The Spanish authorities keep up the pretence that their banking system is sound. Sadly, in this endeavour they now seem to be being aided and abetted by the recently released stress tests. By confining itself to singling out five relatively small Spanish saving and loan banks as unsound, that test gives the overall Spanish banking system a virtual clean bill of health. And it does so despite the system’s patent overexposure to the very troubled construction sector.

In stressing these positives, however, the Spanish authorities happily gloss over the fact that Spain experienced a massive housing boom in the past decade, which saw a trebling in Spanish home prices and an increase in the construction sector to 18 per cent of the economy. 

Since September 2008, the bursting of the Spanish housing bubble together with the collapse of housing-related tax revenues has caused Spain’s budget position to swing from a small surplus to an 11½ per cent of GDP deficit by 2009. At the same time unemployment surged from less than 10 per cent prior to the crisis to more than 20 per cent at present.

More disturbing still, the housing market bust has drawn market attention to the fact that the Spanish banks in general, and the cajas in particular, are overly exposed to Spain’s crumbling housing sector. Unsettled by this large exposure, foreign banks have virtually stopped lending to Spanish banks and companies. This has forced the ECB to have to rediscount about €125bn ($162bn, £104bn) in Spanish bank loans to forestall a full-blown Spanish funding crisis.

Spain now finds itself in a similar predicament to that of Greece. It is forced to engage in severe budget-cutting to bring its budget deficit down to a more sustainable level without the benefit of a cheaper currency to boost exports so as to cushion the economic blow of budget retrenchment. Further complicating is the fact that Spain will have to engage in serious budget tightening at a time when unemployment is already at about 20 per cent and when the domestic housing bust still has a long way to go.

Trying to talk up the markets is the right thing for the Spanish authorities to do provided they do not fall into the trap of believing their own rhetoric. It would also help if they took serious measures to recapitalise their savings and loan banks.