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Spain. Too big to bail?

Spain. Too big to bail?
The ink is barely dry on the Greek rescue deal and more countries may soon be lining up for a bailout. Spain has emerged as the main risk for the EU with some gloomy predictions suggesting Spain will be a worse case than Greece.

After the Greek bond swap the focus has switched back to Portugal and Spain in particular, after the country’s public-debt burden hit record highs. Europe’s fourth largest economy’s overall debt last year amounted to 68.5 percent of GDP – the highest in at least two decades, exceeding the government’s forecast of 67.3 percent. Spain had agreed to cut its annual public deficit to 6.0 percent of GDP in 2011 but it overran that target by a wide margin and ended up reporting a deficit of 8.51 percent of GDP and raising more concerns about its ability to reorder state finances.

On Friday the Spanish government said it’s shutting down 24 public companies as part of its attempts to trim the budget deficit. The current crisis has already driven about 200 000 Spanish firms into bankruptcy. It remains to be seen how this new measure will work for the budget, but it is already clear more jobs will be lost, that’s with the official unemployment rate at about 23% and youth unemployment close to 50%. The probability of social unrest erupting is growing.

Last Sunday hundreds of thousands of people took to the streets to protest the government's tough new labour reforms and cutbacks. The rallies have been seen as a trial of strength before a general strike called for March 29 to oppose the recently approved reforms and austerity measures.

Before approving the reform, Prime Minister Mariano Rajoy was overheard telling European Union colleagues in Brussels that the measures aimed at revitalizing an ailing economy would cost him a general strike. Whatever the cost, Rajoy doesn’t seem to see much threat to push through his reforms hoping to assure investors that Spain doesn’t need a bailout like Greece, Ireland and Portugal.

Meanwhile, Spain's banks are increasing their provisions for bad loans as deflated property prices continues to weigh on Spanish households and banks. Banks hold more than €400 billion worth of loans to the construction and real-estate sector. House prices in the country tumbled at their fastest pace on record in the fourth quarter.

 “There’s no short-term damage at least today,” says Chris Weafer from investment group Troika Dialog.  “Spain sold over €5bln of new debt and they were able to achieve this at the lowest rate for the last 2 years. So at least temporarily bond investors are not concerned about Spanish debt risk. But at the same time there is a concern that this sort of period of calmness in the European debt market is only a brief period in the eye of a storm, and inevitably we will see another blow out with another country’s debt issues. And Spain will certainly be among the candidates.”

Only a year ago, the Bank of Spain insisted that the country’s banking system would need only €20 billion in the 'worst case'. Now this amount has grown to €50 billion. Spain's banking system continues to be even more fragile than is generally believed. A government bond auction on Thursday still drew less demand than expected and the treasury sold less paper than it had planned although yields remained fairly low by recent standards. After Greece, efforts from the ECB and all EU leaders are now directed towards structural change in the European debt and banking system to head off any problems in bigger countries like Spain at an earlier stage and not get into the same situation as Europe got into with Greece.

“People are aware that if another big country gets into problems, then the already fragile European banking system, not just the Spanish banking system, but the regional banking system in total could be at serious risk,” says Weafer. “With a bigger country the consequences would be much more severe and probably not containable as they were with Greece”.

So it is not so much all about Spain's situation being “better or worse than Greece's”. The problem is that a crisis in Spain matters a lot more to the future of the eurozone than the crisis in Greece.