SPAIN IS NOT GREECE AND NEED NOT BE IRELAND / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Spain is not Greece and need not be Ireland

By Mohamed El-Erian

Published: February 3 2011 13:30


Spain is an important battleground when it comes to the success of efforts to stabilise the debt crisis in Europe’s periphery and to limit the contamination of the region’s core. To win this battle, the Spanish authorities must move quickly to restructure their cajas (unlisted regional savings banks) and do so without further destabilising their public finances.


Spain’s success is of acute relevance to the rest of the eurozone. If Spain is not successful, Europe’s existing rescue mechanisms and approach would be overwhelmed, raising doubt on the sustainability of the eurozone’s weaker countries (such as Greece, Ireland and Portugal). It would also lead to renewed pressures on the value of the euro, on German interest rates, and on the credibility and integrity of the European Central Bank.


First, the good news. Unlike Greece, Spain does not have a direct public finance crisis. At just over 60 per cent of gross domestic product (compared with double that level in Greece), the public debt stock is much more manageable. Indeed, on the basis of just its public finances, Spain does not face a debt overhang that is sufficient to undermine growth dynamics and torpedo sovereign debt spreads.


The challenge to Spain’s budget deficit and debt comes not from direct indebtedness but, instead, from “contingent liabilities” – that is to say, the liabilities of other sectors that the government may decide to assume in order to curtail further economic and financial disruptions.


Spain is where Ireland was a couple of years ago. In the next few weeks, it has to choose whether to use the government’s balance sheet to recapitalise the cajas’ struggling balance sheets and whether to assumes their losses. Moreover, the cajas are not the only sector facing debt overhangs in Spain and, consequently, posing contingent liabilities for public finances. Property is also a concern, as are some segments of the private sector.


The Irish government decided to use its balance sheet to absorb the bulk of the losses of its private banks. Taxpayers were put on the line for past bank excesses, while most creditors and all depositors were let off the hook.


Ireland’s decision was driven by the judgment that a broader burden-sharing, including imposing haircuts on more creditors, would be highly disruptive. In reality, no one can ever know the counterfactual.


What is clear is that, at an estimated 30 per cent of GDP, the burden from the bank rescue efforts has proved excessive for Ireland’s public finances. The banks’ problems have now totally overwhelmed budgetary resources, turning a banking crisis into a full-blown sovereign debt crisis. As a result, the country now depends on bail-out funds from the International Monetary Fund and its European partners.


Spain is clearly keen to avoid Ireland’s experience. The central bank is forcing reform on the cajas, and pushing them hard to recapitalise. And some cajas, like Catalonia’s Caixa, are actually making concrete and meaningful efforts to raise private capital.


These are important steps. But they are just a start: the cajas have dug themselves into a deep hole. Estimates for the sector’s capital needs vary enormously. Reflecting the still-large degree of valuation uncertainties, some are as low as €20bn ($27.6bn) while others are as high as €100bn. Moreover, the cajas still account for an important part of deposits whose stabilisation is key to Spain’s well-being.


If it continues to move forcefully, Spain has the ability to avoid Ireland’s unfortunate situation. But this is far from certain; and it is not automatic. To avoid a bad outcome in Spain (and the rest of the eurozone), additional, significant and highly visible progress needs to be made within the next few weeks to pump capital into the cajas, aggressively dispose of assets, and strengthen them institutionally, including through mergers for some.


The writer is chief executive of Pimco

Copyright The Financial Times Limited 2011