Spain and Portugal rushed back to intensive care as debt crisis turns again

Spain and Portugal’s economies have been rushed back into the financial equivalent of a hospital intensive care unit after spreads on their debt increased sharply on the threat of contagion spreading to the eurozone’s third biggest economy Italy.

Last week’s interest rate hike by the European Central Bank (ECB) was already seen as a possible trigger of further problems in the currency area, but the twin factors of Italy being put on watch and Portugal’s central bank publishing poor economic figures pushed the international market in sovereign debt to run for the relative security of Germany.

There are of course some key differences between Spain and Portugal. According to a comment published in InvestmentEurope on 11 July by Ted Scott, director Global Strategy at F&C Investments, Portugal’s sovereign debt was rated Ba2, BBB-, and BBB- by Moody’s, S&P and Fitch respectively. Spain’s debt was rated Aa2, AA, and AA+. This is a considerably better position to be in.

Also, the ECB has sought to maintain focus on stimulating investment across the eurozone; its deposit rate remains 75bps below the refinancing rate, which was hiked 25bps to 1.5% last week. The deposit rate remains 150bps below the marginal lending rate, which was also raised 25bps to 2.25%.

But that argument fails in light of recent macroeconomic figures from Spain and Portugal, and the debt market has reacted.

Latest data published by Reuters shows that Spanish 10-year yields rose to 6.23%, with the cost of insuring against debt default rising to a record high.

One of the issues facing the country this week is the unkown impact of the EU’s latest stress test of banks. Financially fitter countries such as Sweden were fast to put markets on notice last week that none of their banks had failed the test. But the outlook for Spain is less certain, with markets not being told if any of its banks have failed the test before the European Banking Authority publishes its full results on Friday this week.

The uncertainty that these results could spark for creditors to Spain is highlighted in a letter that Greece’s prime minister George Papandreou released early on Tuesday 12 July targeting EuroGroup chairman Jean-Claude Juncker, and finance ministers of the EU’s 27 member states gathering in Brussels. Papandreou said: “We all also know that, because there is still a deep distrust about the financial health of the banking system in Europe, that the new “stress test” results to be announced in a few days may fuel yet more market insecurity.”

The Bank of Spain published data earlier that showed a big turnaround in expectations of industrial investment compared with expectations in 2010. But the picture is far from clear, as the Bank also published figures on other indicators, for example, the consumption of cement, which fell for three straight months to June.

Crucially, the country’s balance of payments remains negative, according to the Bank’s own statistics. Without a significant improvement in the balance of payments, creditors will continue to wonder how the economy will be able to pay back its loans.


The Bank of Portugal’s outlook published in the past 24 hours was poorer than expected.

Estimates are that GDP will shrink -2% in 2011, and -1.8% next year. This comes after anaemic growth of 1.3% in 2010. GDP growth has averaged less than a percentage point in the past decade according to figures published by Bloomberg. It adds that the previous forecasts projected a -1.4% decline in GDP this year, turning to positive growth of 0.3% by 2012.

Slightly more positive are the projections for a shrinking current and capital account deficit, halving to 4.4% by 2012 from a level of 8.8% in 2010. Exports are also forecast to remain in positive territory, at 7.7% this year and 6.6% next year.

However, as with Spain there are fears that investment in the Portuguese economy will decline, threatening its ability to maintain growth going forward. Investment could fall more than 10% in 2011 and 2012, even as consumption continues to shrink. The European Commission estimates that Portugal’s debt will continue to increase through next year. If growth does not improve the burden of that debt will rise even further.

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