Spain is the Pain

Currency in Crisis

If there was a doubt about it, there isn't any more. The European debt crisis is not simply a Greek phenomenon. Spain is the focus now. Spain (sovereign and private) owes foreign investors roughly $1.1 trillion. In comparison, Greece's external debt is closer to $236 bln.

Besides the news that every one is now aware of (a savings bank taken over by the central bank over the weekend, the merger of 4 additional banks and the IMF's warnings), two other developments are noteworthy.

First the good news. Spain reported today that is central government deficit in the first four months of the year narrowed to 5.66 bln euros from 6.91 bln euros in the same year ago period. This is about an 18% improvement. Recall that just last week, Spain announced additional cost cutting, including a 5% reducing of civil servant salaries and a freeze on pensions. Note that it does not include the social security system or local governments.

That is a good segue to the second and not so good news. Yesterday Spain seemed to indicate that it was banning local governments from taking on any more long-term debt. The local papers today are clarifying this to mean that the ban will come into effect on 1 Jan 2011 and last a full year. Local governments last year accounted for nearly 0.55 percentage points of the 11.2% deficit.

This is a timely reminder of the importance of local governments in Europe and their borrowing. In some countries, including Italy and Germany, the borrowings can be substantial.

The point in Spain however is that if local governments can't make long terms borrowings next year, wouldn't increase the incentives to borrow (if they can) this year?