ECM’s Pulle contemplates the capital controls option for Spain

Satish Pulle, lead portfolio manager for Financials at ECM, believes that the time may have come for Spain to consider capital controls as part of a drive to focus domestic savings into domestic government bonds.

Spain has a large diversified economy with GDP of €1,070Bn, it is one of the richest countries in the world with GDP per capita of $32,470 per annum (December 2011). While construction and real estate sectors contributed excessively to GDP growth until 2007, they have also contracted substantially since then.

Meanwhile, the Spanish export sector (circa 25% of GDP) has been more resilient, and Spain has managed to keep its share of world exports largely intact over the last decade, despite headwinds from a strong currency and loss of competitiveness relative to Germany. Spain is regaining its relative competitiveness more quickly than say Italy. Spanish export sectors are reasonably diversified, and so are Spain’s trading partners (57% Euro area, 43% other). While export growth can help GDP, Spain needs to pull many other economic levers too.

While official unemployment figures are high at circa 24.6%, Spain is also known to have a large and probably growing “underground” economy, so true unemployment may be lower.

At the level of the fundamental economy therefore, Spain seems to be adjusting reasonably well. Yet, Spain also has a long distance to travel to become a better place to do business.

According to the World Economic Forum Global Competitiveness Index 2011-12, Spain ranks 36th out of 142 countries on competitiveness. This reasonable overall ranking is weighed down most by the competitiveness indicators that matter most to medium term GDP growth: goods market efficiency (66/142), labour market efficiency (119/142) and financial marker development (64/142). Spain has an uphill task to climb to improve competitiveness substantially along these critical indicators, and very little time in which to do it.

How much time does Spain have? As much time as the debt markets are willing to finance government debt, which depends on debt levels, refinancing needs, debt providers, and their appetite for rolling over maturities.

Just how much debt does Spain have? While the headline direct central government debt level is reasonable enough at 68.5% of GDP, The Bank of Spain measure stands at 86.8% as it includes €100Bn of unpaid commercial bills (9.5% of GDP) and €55Bn public enterprise debt. Yet even this higher Bank of Spain number does not include debt issued by directly government guaranteed entities such as the FROB (€11Bn outstanding, €27Bn maximum); FADE (€13Bn outstanding, €22Bn maximum), and ICO (€75Bn outstanding, no maximum), or the €60Bn government guarantees of bank senior debt. While some of these are contingent liabilities, they do appear on bond investors’ list of concerns.

In addition to the reasonably high central government debt level, the Spanish private sector is also highly leveraged – with the household debt at 80% of GDP and non-financial corporate debt at 120% of GDP. Spain’s economy-wide debt therefore is as high as 300% of GDP, compared to say 225% in Italy (where high government debt of 120% of GDP is offset by more manageable private sector debt).

Not only are debt levels high in Spain, but upcoming maturities are too. Excluding the €100Bn financial sector aid from the EU/EFSF for the Spanish Financial sector, government and related entity financing needs are estimated at €100Bn for the rest of 2012 and €150Bn for 2013. In addition, t-bill issuance for H212 stands at €17Bn.

All this debt needs to be issued at a time when ratings are falling fast – Moody’s downgraded Spain 7 notches from Aa2 in June-11 to Baa3 in June-12; S&P downgraded from AA- in May-11 to BBB+ in April-12, an Fitch downgraded from AA- in Dec-11 to BBB in June-12, all agencies remain on watch negative. These downgrades, and the high price volatility of Spanish government bonds over the last few quarters have scared away the largest group of bond buyers – index benchmarked government bond funds. In fact, Morgan Stanley analysts recently estimated that benchmarked investors could be forced to sell €30-€66Bn as further downgrades push Spain into sub-investment grade ratings.

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