Pain in Spain

The euro area finance ministers will focus on securing aid for Greece at tomorrow's meeting.  The aid that it will receive will enable it to service its debt, of which three quarters is in official hands (ECB, IMF and EU).  It will not be used for other government expenditures.  In this sense, the aid is not bailing out Greece but keeping its official creditors whole

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The finance ministers meeting keeps Greece front and center, but Spain is on the wings.  Earlier today the central bank reported that non-performing loans rose to 10.7% (roughly 182 bln euros) in September from 10.5% in August.  It is the fifteenth consecutive monthly increase.  

However, Deputy Economic Minister Latorre is quoted saying that Spanish bank capital needs are fallen and less than 40 bln euros of aid is needed.  Recall European officials have earmarked 100 bln euros for Spain's bank backstop.  Previously private sector estimates were for a little more than 60 bln euros.                                

Although France, Italy and the IMF are clamoring the loudest for Prime Minister Rajoy to formally request aid, Spain itself is not under much pressure from investors.  Spain's 10-year yield is about 100 bp above the average over the past five years and down roughly 200 bp since the last July peak.   Rajoy does not know, nor can the ECB know, how much Spanish yields will fall if a formal request for aid is made and OMT and ESM buying is triggered.

Spanish officials claim to have met this year's funding needs, but given the budget overshoot and new needs (e.g. regions), and the draw down on its cash buffer, it is not immediately clear if this is really true.  In any event, Spain will be holding a few more auctions this year.  It will seek to raise 3.5-4.5 bln euros in bills this week and 2.5-3.5 bln in bonds (Thursday).  

         
Official figures show foreign investors increased their holdings of Spanish debt in September to now hold 35.4%, up from 33.5% in August.  However, anecdotal reports suggest that more recently some foreign investors have taken some profits. Indeed since the middle of last month, 2-year Spanish yields have risen 70 bp to 3.35% today, the highest since Oct 11.  The 10-year yield has risen a little more to reach last week's high just below 6%, which was the highest since late September.                                                       

Pressure on Spain is likely to mount and this, we suspect, will force it to formally request assistance in the new year.  The source of the pressure will likely come from Spain's funding needs.  The budget calls for the sale of some 207 bln euros, but this could increase due to a deficit overshoot, which the market expects and/or more regional needs, as most regions remain locked out of the capital markets.  Spanish banks doubled their holdings of Spanish sovereign bonds this year, apparently helped by the two LTROs.  Spanish banks have reportedly nearly exhausted their capacity to buy substantially more government bonds.

A new law went into effect today in Spain that limits most cash transactions to less than 2500 euros in an attempt to curb tax evasion.  Spanish tax inspectors estimate that the underground economy (cash economy) is as much as 23% of GDP, well above the euro area average of 13%.  Note that Italy cut the maximum cash transaction to 1000 euros last year.  

                               
Lastly, Catalonia holds local elections this coming weekend.  The latest polls show the nationalists are likely to win, but some reports are suggesting that the secessionists may not secure a majority and this would ease one of the sources of anxiety.  Some see the Catalonian election as a necessary but insufficient hurdle that needed to be overcome before formal request for assistance is politically practical.