A Vicious Circle for European Governments

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A Vicious Circle for European Governments

News Article Date: Tuesday 15th of June 2010

As financial markets demand higher interest rates on its debt, Spain, like a number of economies in Europe, is battling to persuade skeptical investors that it can continue to service its mounting financial obligations.
Click here for more information about mortgages in Spain People seeking jobs lined up at an employment office in Madrid on Tuesday. At a closely watched auction for 12- and 18-month bills on Tuesday, the Spanish government raised €5.2 billion, or $6.4 billion. The rate of 2.3 percent on the 12-month bills was a sharp rise of 0.7 percentage point from the rate it paid last month and a return significantly higher than in other major euro-zone economies. The result heightened longstanding fears that Spain’s financing costs could soon become too high for the economy to bear. The increase in yields comes amid reports in the German press that Spain may become the first country to tap into the recently cobbled together European rescue fund set up last month, a possibility that has been emphatically denied by Spanish and European Union officials. The head of the International Monetary Fund, Dominique Strauss-Kahn, will travel to Spain on Friday for talks on the economy with Prime Minister José Luis Rodríguez Zapatero, Reuters reported Tuesday from Washington, quoting an I.M.F. spokeswoman. “He is in Europe this week, and is taking this opportunity to discuss global economic developments with the prime minister, and to consult with him on developments in Spain, including the government’s economic policies and reforms,” the spokeswoman, Simonetta Nardin, said in a statement.
Click here for more information about mortgages in Spain “Things are getting worse for funding of Spanish banks and corporates, but Spain is not insolvent,” said Jonathan Tepper, an expert on Spain’s economy at Variant Perception, a research firm in London. “It could be illiquid though if people don’t turn up for bond auctions.” With a total debt of 115 percent of gross domestic product as well as a huge annual deficit, Greece had a problem of insolvency in that it could no longer generate the cash needed to repay its debts. With a debt one-half of Greece’s, but a similarly high deficit, Spain faces no bankruptcy threat. But it remains reliant on foreign bond investors to provide financing — most acutely, €50 billion by the end of the summer — as it focuses on cutting its deficit and improving its export competitiveness. When foreign investors stay away, as many have of late, Spain has to rely on its banks for funding. And as Spanish banks themselves find it more difficult to borrow from peers abroad, they are turning to the European Central Bank as their lender of last resort. That is what happened in Greece in the weeks before it had to turn to Europe and the I.M.F. for assistance. The result, ultimately, of this vicious circle is a persistent increase in borrowing costs that, over time, begins to supersede an already sluggish rate of growth and become what economists call a debt trap. This rise in rates and the expanded role banks are taking in lending to governments comes at a time of growing pressure on the European Commission, which enforces the budget rules of the European Union, to release results of stress tests for major financial institutions in Europe. The Committee of European Banking Supervisors is working on stress-testing big financial institutions now, with results expected soon. They will be discussed with the commission, the European Central Bank and the 27 E.U. member states in late June. Germany and France have resisted releasing the results, fearing perhaps that they could be required to cough up more state aid to bolster weaker banks. But the E.C.B. has been pressuring regulators to make more information about the stress tests public, as has the U.S. Treasury secretary, Timothy F. Geithner.
Click here for more information about mortgages in Spain The Spanish daily El País quoted unidentified people in the government Tuesday as saying Madrid wanted E.U. regulators to publish the results of stress tests of individual banks to restore confidence. The Spanish Bankers’ Association also said the stress test results should be made public, Reuters reported. Chantal Hughes, a spokeswoman for Michel Barnier, the European commissioner responsible for financial regulation, said, “Information resulting from stress tests is sensitive and must be dealt with appropriately.” Ms. Hughes also hinted, however, that Mr. Barnier might support the release of some data, and a German official, speaking on condition of anonymity ahead of a summit meeting Thursday of E.U. leaders, said it was one of several options being considered. In fact, even countries seen to be part of core Europe, like Belgium, have had their borrowing costs increase in recent days even though their budget deficits remain relatively low compared with outliers like Spain and Ireland. Driving this trend are the steep financing requirements they face this year. According to the I.M.F., the three countries in Europe that will need to raise the most money to finance their debt burden this year are, in order, Italy, Belgium and France, which face gross financing needs of 26.4, 25.9 and 25.1 percent of G.D.P. Until now, investors have drawn a distinction between these counties and more crisis-prone economies like Greece, Ireland, Portugal and, now, Spain. But as growth rates in these economies remain stagnant, focus is now turning to their high debt levels: 117 percent of G.D.P. in Italy, 97 percent in Belgium and 77 percent in France. Even in France, which has been seen as a haven of sorts, rates have risen to just over 3 percent from a low of 2.8 percent. And in Italy, rates have moved to 4 percent from 3. 8 percent over the past two months. But it is Belgium that has experienced the most pronounced move, with the interest rate on its 10-year bond rising 11 percent over the past three weeks, to 3.5 percent, as worries built that the growing political influence of the secession-minded Flemish party may make it harder for a strong government with budget-cutting credentials to be formed. The European Commission kept up pressure Tuesday on Spain and Portugal, telling both countries that they needed to outline specific measures to show how next year’s targets for curbing deficits would be met. “Spain is on the right track, but, concerning next year, it is essential to substantiate these new concrete measures,” Olli Rehn, the European commissioner for economic and monetary affairs, said in Strasbourg. Portugal, too, should define clear-cut measures to convince the markets that its targets can be met, Mr. Rehn said. Such “concrete measures” should be “included in the budget for next year.”

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