Spinning Spain

Spanish bonds and stocks have advanced today, but we remain profoundly skeptical of claims that the country has turned a corner. Shortly after announcing what the EU's Ollie Rehn suggested was an austere budget that went above EU recommendations, Spain revised its 2012 budget deficit.

Recall that the 2011 deficit was recently revised to 9.4% from just below 9%. For this year, the EU gave initially gave Spain a 5.3% target. In May, coming out of an EU summit, Prime Minister Rajoy indicated a much higher shortfall and later compromised with the EU for a 6.3% shortfall. It now says the deficit, when including the cost of support for troubled banks (as Ireland and Greece have done) will be closer to 7.4% of GDP.

Spain says that the 2013 shortfall will be 4.5%, as the EU requires. Yet one of the key reasons behind its projection is an optimistic assumption about growth. It assumes the economy will contract by 0.5% next year. 

Banco Santander, Spain's largest banks, forecasts a contraction twice as large next year and the Bloomberg consensus is for a 1.25% contraction. There are other questionable assumptions, including a decline in unemployment and only small declines in house prices, for example.

Spanish officials have blamed the fiscal overshoot on the regions and on the banks, but there is more to the story. Next year's budget, for example, projects 25 bln euros of aid of the electric industry, which is greater than the aid earmarked for the regions.

Leaving aside these budget machinations, there are three issues that hang over Spain here in October. First, many expect Moody's to complete its ratings review of Spain. It was anticipated last week by many observers, but there is no fixed date. Second, there are local elections in Galicia and Basque Country on Oct 21. Separatists in Basque Country may be emboldened by the moves in Catalonia to seek independence. Rajoy meets with the regional leaders tomorrow to try to head off the looming constitutional crisis. Third, Spain has a large debt payment due at the end of the month (20.3 bln euros).

While many observers have been looking for Spain to formally request aid sooner, we understood that Rajoy would seek to avoid formal request for aid until after the local elections. The impact of the unveiling of ECB's Outright Market Transactions scheme has perversely helped delay such a request. Moreover, contrary to what the ECB intimated about gaming its purchases of sovereign debt with 3-years or less until maturity, Spain's 2013 funding plans appear to call for more short-end issuance and a reduction of the average maturity of its outstanding debt.

Spain will be selling bonds on Oct 4 of 2015, 2015 and 2017 maturities, seeking to raise 3-4 bln euros.