Spanish bailout a win for Italy, suggests Natixis’ Patrick Artus
Patrick Artus, global chief economist at Natixis, says Italy could become an unlikely winner from any Spanish request for financial assistance, which could lower interest rate costs for other eurozone members.
When Spain finally decides to ask Europe for financial help, it is more than likely all eurozone countries’ interest rates will fall, thanks to investors switching from Spanish bonds into other European sovereign debt. But considering the significant economic and political challenges facing Spain, the lowering of government borrowing rates will only provide a limited fillip. Italy, on the other hand, stands to benefit.
Spain’s prime minister, Mariano Rajoy, has so far resisted requesting help, possibly on account of demands from Germany’s chancellor, Angela Merkel. But even with interest rates on government bonds dropping significantly since the start of the summer, following the creation of the European Stability Mechanism (ESM), the European Central Bank’s (ECB) government bond purchase programme (Outright Monetary Transactions, OMT), and bank recapitalisations, Spain will still have to ask Europe (specifically, the ESM and ECB) for help.
Despite the recent fall in yields, interest rates on Spanish, Italian and Portuguese government bonds have spread to the same level that banks and companies have to pay. This is unsustainable in Spain, not only given the size of Spanish public debt (100% of GDP), but also due to the scale of Spanish banks’ and, especially, private-sector debt (200% of GDP).
Combined with the prospect of anaemic growth, Spain will be obliged to ask Europe for help. The difference between its interest rates and growth rate is simply unsustainable – it cannot finance itself. Yet the situation for Italy is different, for two reasons. First, it enjoys a primary fiscal surplus, as well as a trade surplus, and as such has no fundamental reason to request aid. Second, it has very large government borrowing requirements. Given that the ESM is supported by capital provided primarily by Germany, France, Italy and Spain, such a system can subsist if only Spain must be financed, but will collapse if both Spain and Italy need to be financed.
When Spain eventually relents and asks Europe for help, interest rates will fall markedly not only in Spain, but also in Italy, Portugal and Ireland, and even in the core euro-zone countries. The majority of Spanish government bond issues are currently being bought by Spanish banks. If the ESM buys 50% of the Spanish Treasury’s issues in the primary market (which seems reasonable) and if the ECB buys Spanish government paper in the secondary market – driving up their price – previous buyers of Spanish debt will inevitably switch to other government bond markets. They will look towards Italy and Portugal to achieve high yields, but also to core countries (France and Germany) in order to secure their portfolios and attracted by the liquidity of these markets.
All eurozone countries will therefore stand to benefit from lower interest rates when Spain obtains European support. And it is unlikely that this pooling of sovereign risk will affect core interest rates to any significant extent.
Yet, it would be misleading to believe this fall in interest rates by itself means that Spain’s problems are over. Given Spain’s public finances, particularly its trade balance and unemployment – stemming from the collapse of employment in construction and related industries – Spain will remain in a challenging economic situation.
By contrast, Italy’s woes are focused on its abnormally high interest rates, which are constraining credit and investment in the Italian economy. Lower interest rates for all borrowers, meanwhile, will help stimulate growth. As a result, and perhaps paradoxically, Italy stands to benefit more when Spain eventually submits its request for help.