From a banking-only to a full EU bail-out to support debt-ridden Spain?

After months of Spanish President Mariano Rajoy’s denial for the need to bailout Spanish

financial sector, the deterioration of the Spanish economy, left the country with no other choice

than seeking support from its Eurozone counterpart. With Spain borrowing costs remaining

dangerously high, fears are growing that it could follow Greece, Ireland and Portugal in a full-

scale bail-out.

EUR 100 billion banking support

Ending weeks of speculation, Finance Ministers of the Eurogroup agreed on 20 July by unanimity

the terms and conditions for the restructuring of the Spanish financial sector to take place in the

upcoming 18 months. In a targeted bail-out to be the first of its kind, countries in the Eurozone

agreed to lend up to EUR 100bn to bolster Spanish bank while imposing only limited austerity

measures.

The funds to recapitalize Spanish banks will come from the European Stability Mechanism,

which is expected to come into operation mid-September. Restructuring plans in the banking

sector will have to comply with the EU state aid rules while Spain will be expected to maintain

its commitments to correct its excessive deficit in a sustainable manner by 2014.

If the measures announced proved beneficial in the short term to calm markets, it did not

convince Spaniards, who are strongly opposing austerity measures introduced in recent months.

Since the Spanish government announced EUR 65 billion in new spending cuts earlier this

month, regular mass demonstrations have taken place fragilising the conservative Prime

Minister Mariano Rajoy, who took office at the end of last year replacing the Socialist Jose

Zapatero. Supporting the Spanish people, the European Trade Union confederation warned that

the “budgetary cuts, which have also strongly hit Italy, Portugal, Greece and Ireland, are merely

ideological and are undermining social cohesion”.

A structural crisis

With the highest unemployment rate in Europe exceeding 20% of the active population, the 4th

economy in the Eurozone suffers particularly from the aftermath of the 2008 financial crisis.

Spain had high private level of external debt owned both by firms and households, with the real

estate and construction sectors being key drivers for the current crisis. The collapse of the

housing bubbles & record high public debt levels, in particular in several Spanish regions, such as

Valencia and Catalonia, left Spain particularly vulnerable to the current spikes of recession in

Europe.

A weak fiscal framework

The Spanish situation can also be seen as an outcome of poor economic governance in the euro

zone widely perceived as lacking a coherent strategy to calm markets and stabilise economic

activity. The diversity of fiscal and economic policies of the Member States compromises the

good functioning of the euro, considering that the euro launch was a process driven by entry

requirements and limited attention was paid to long-run optimality. The framework for fiscal

policy embedded in the Stability and Growth Pact has failed to provide a credible framework for

the conduct of fiscal policy.

IMF says “Spain is taking steps towards stability”

International organizations such as the International Monetary Fund (IMF) highlights that Spain

is on the right track to recovery having implement major policy changes to boost Spanish

economy such as the new regional liquidity funding mechanism. Christine Lagarde, IMF director,

expressed her satisfaction with the Eurogroup decision to back-up the recapitalization of

Spanish Banks and highlights that “the implementation of these measures will contribute to

significantly strengthen Spain’s financial system, an essential step in restoring growth and

prosperity in the country”. However, the IMF also underlined the urgency of additional progress

to boost competitive and employment despite recent labour market measures.

The seven most developed nations consider the bailout to the Spanish banks as an important

step forward for the euro zone to reinforce a strong fiscal and monetary union. However, the

parliamentary group ALDE believes that the bailout is not the solution to strengthen Spain or the

Eurozone and highlights that the only solution will be to back up unstable European countries by

installing a collective redemption fund based on common bonds. ALDE argues, “Unfortunately

there are no more quick-fix options left”.

Towards a full scale bail-out?

Nevertheless, Jean-Claude Juncker, the head of the group of eurozone finance ministers believes

that the European Central Bank (ECB) should buy some Spanish government bonds to reduce

Spain’s borrowing costs in addition to the bailout. A plan might be in the making to restore

confidence of the markets in the survival of the Euro to be released towards the end of August.

The fact is that the banking sector bail-out implementation is still uncertain and it is not going to

address main European priorities such as the lack of investors’ confidence in European markets,

the Euro weakness compared to other currencies and in the case of Spain the high level of

unemployment.

If the situation in Spain continues to deteriorate, with risks of Spain needing to default if it can’t

repay its debt on markets anymore, the Eurozone would have to support Spain with a full-bail-

out. The UK-based think tank Open Europe estimates that taking Spain off the markets for three

years in a bailout would cost between €450bn and €650bn. Therefore, the question that

everyone is thinking about is: Will this new bail-out to Spain’s financial sector going to be

enough.