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The situation in Spain deserves some attention. EU finance ministers have approved an aid package for its banks, but the number of Spains autonomous regions asking for financial assistance has grown by the day and may prompt the 4th largest economy in the European Monetary Union (EMU) to request a full bailout.
I asked my colleagues, Monica Defend, Head of Global Asset Allocation Research and Cosimo Marasciulo, Head of European Goverment Bonds and FX, to shed some light on the situtation. A summary of their thoughts follows . . .
Spain’s Situation Different from that of Ireland in 2010
The consensus scenario gaining ground is that the worsening condition of Spanish banks may hurt central government finances right away and the cost of a bailout may become prohibitive just when fiscal policy has turned restrictive.
The case of Irelands bailout in November 2010 was a telling example, though Spain has fuelled more concerns both for the larger size of its economy and for the additional burden of its autonomous regions. Among those regions already asking for financial assistance are two of the largest, Catalonia and Valencia, but the number may be growing.
Some investors point to another difference from Ireland (whose sovereign credit spread has converged on Spains of late), which is Spains inflexible economy. The government has announced another round of tax increases and spending cuts, which have further reduced households disposable incomes and the ability to pay down debt. Banks nonperforming loans are expected to rise further as a result.
Such austerity measures may extend the recession in a rigid economy. The best case in point is probably the labor market. While wages have dropped sharply in Ireland as a result of the last recession, there is little evidence of that happening in Spain. Lower labor costs should be the easiest way to restore competitiveness if the currency cannot be devalued, as the Bank of Spain pointed out in its monthly bulletin.
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To read the complete report written by Monica and Cosimo, which includes their broader analysis of the other EMU economies, the strengthening role of the European Central Bank (ECB) and factors affecting the non-EMU regions, click here or visit Pioneer’s web site.