Spain is next in the firing line, for unless this coming budget on Friday astounds us all there is a high chance that it will need a eurozone bailout. The pattern is a familiar one, for Spain seems to be heading down the same path as Greece, Portugal and Ireland before it. First there is the denial that there is a problem; then there are arguments put forward that the situation is different from other indebted nations and that a credible austerity programme is in place; then leaks unhelpfully emerge that the country is under pressure to accept European funds; then finally comes the bailout. Along the way there is a change in government.
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Spain is at the leaks stage now, with stories emanating from Brussels that it is being pressed to accept help. The stories are denied, as they always are, but they are there for a purpose: to put pressure on the government to accept formal support, instead of relying on informal support via the European Central Bank. (Spanish banks have been the largest users of the ECB's special lending scheme and the evidence is that rather than increase their commercial lending, the money has instead gone to buy Spanish national and local government debt.)
The budget on Friday will seek to cut the budget deficit from 8.5 per cent last year (itself an overshoot from a predicted 6 per cent) to something between 5 per cent and 6 per cent. But it is hard to see how it can do so. The new Prime Minister, Mariano Rajoy, has promised to present a budget that will be "very, very austere", but pushing more austerity on to an economy already in recession may do more harm than good, for the numbers are really quite frightening.
Spain's problem is not so much the level of public debt, around 70 per cent of GDP, but rather the level of private debt, the level of unemployment and the solvency of its banks. You can catch some feeling for this from the numbers in the top graph: consumption squeezed down year after year, GDP back in recession and unemployment at 25 per cent, the highest in the world. Youth unemployment is around 50 per cent, a social catastrophe. The projections here are from HSBC and are slightly worse than the official ones from the European Commission and the Spanish government, but even were the official ones right the country is still in dreadful trouble.
Much of that trouble is the result of the hangover from the property boom. Anyone visiting the country will have become aware of the ranks of unfinished apartment blocks, the physical evidence of that. But there is the hidden evidence too, the fact that the property market is not clearing, for values are still too high relative to demand. As a result banks hold on their books loans that are nominally still covered by the value of the property they financed but in reality are under water. You can catch a feeling for the scale of the lending boom from the second graph, which compares lending by Spanish banks with that of German ones during the boom years and subsequently. As property prices continue to decline, many Spanish banks that are at present notionally solvent will need some sort of rescue by the government, which will put further pressure on its own finances. This is Ireland's situation: public finances that appeared all right until the recession but unable to cope with the additional pressure of bank rescues.
So what will happen? Well, we will get the budget, which was delayed until the regional elections that have just ended. There will then be a pause as it is assessed not just by the European banking and investment community but by the Spanish people. The issue is an economic one, of course, but it is also a social one: how much austerity can you force on a people?
The UK government is openly worried about social and financial unrest in Spain for the obvious reason that we have a million British people there. This is a story that affects us directly in the way that Ireland does but Greece does not. However, unlike Ireland, Spain is not such a significant export market, so the incentive for the UK to join in any support operation is minimal.
It is hard to do more than sketch how events might unroll in the months to come, but the balance of probability must be that it will need EU support of some sort. Citigroup's latest assessment, just released, sums the situation up, noting that Spain "is not bound to restructure its debt, let alone default. But we believe that the risk of a Spanish sovereign debt restructuring is higher now than it has been since the crisis started".
It believes that the big numbers for growth this year and next are likely to be even more negative than official forecasts (and the HSBC ones above), expecting the economy to shrink by as much as 2.7 per cent this year and 1.2 per cent next. Under these circumstances Spain will be unable to meet its budget targets. On top of that, the state will need to rescue its parts of its banking system as property prices continue their decline.
This is a serious assessment, and the bank is clear that the path to a rescue is not clear or certain. But that would be the natural conclusion from its analysis, and of course once it becomes clear that a country has to have a rescue, events take charge. There may be a few months respite, but once a country is on the glide-path to needing a rescue it is hard to get off it. You then have to think about the consequences that yet another rescue will have on the eurozone itself.
There can be no doubt that rescuing Spain would stretch the resources of its eurozone partners, however the burden is distributed. But it may be do-able. I don't think Spain leaves the eurozone just yet.
But a rescue does nothing to improve the country's competitiveness within the eurozone. For that, it needs a devaluation, something unthinkable – as yet.