I’m becoming increasingly irritated by leaders of the eurozone referring to higher bond yields as “attacks” by the bond market. These aren’t attacks, they are just a common sense reaction to the increasing risks involved in lending money to the regions so called PIIGS, i.e. Portugal, Ireland, Italy, Greece and Spain.
Just last week Italy’s Prime Minister, Mario Monti, stated that without a successful outcome at the EU summit (scheduled for June 28-29 in Brussels), “there would be progressively greater speculative attacks on individual countries”.
Spain in the crosshairs
When bond investors lend money to a nation (or even a company or individual) they do so on the basis of risk versus reward. As the risk of being repaid in full diminishes, as it has done recently with Spanish debt, bond investors demand higher rewards for holding that debt, i.e. they insist on higher interest rates.
The fact is that Spain is in deep trouble and personally I wouldn’t lend it money at any rate of interest. Officially Spain’s debt to GDP ratio is reported as 68.5%, however thanks to Mark Grant, Managing Director of Southwest Securities, we can see that Spain’s true debt to GDP ratio is actually 146.6%.
Spain’s debt to GDP ratio: The true figures
Data courtesy of Mark Grant
In addition to its debt problem, Spain is suffering from depression levels of unemployment (24.1%, with 51% youth unemployment) that’s 5.64 million people out of work, and there are no signs that their situation will improve anytime soon.
In March of this year Spain announced a new budget which was described by the BBC as being part of “one of the toughest austerity drives in its history”. The budget outlined €27 billion (£22.5 billion) in cuts, equivalent to 2.5% of Spain’s economic output. The problem however, is that even a cursory analysis of these cuts quickly reveals that they are not enough to meet the commitment made to the European Commission to reduce Spain’s deficit from 8.5% to 5.3% of GDP this year.
In addition 45% of the planned cuts are supposed to come from increased taxes, and if history teaches us anything it’s that higher taxes lead to lower government revenue, not higher revenue. Just ask Greece.
Not only are the budget cuts too little too late but the policy reforms necessary to foster economic growth were also notably absent.
The bottom line
Spain had three years in which to address its budget deficit, but it failed to do so. The reality is that far from attacking Spain, the markets are merely trying to instil some fiscal discipline. In effect bond investors are saying get your house in order or we will do it for you.