August 23, 2012 7:16 pm
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Beware the five common myths about the Spanish economy
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The quantum physicist Niels Bohr once said that “every statement should be taken by a scientist as a provisional hypothesis that has to be tested”. The same holds true for the five most repeated arguments about the Spanish economy – myths that are too often today accepted without scrutiny by investors who allow their thinking to be muddled by market noise. Those who look beyond them will see the market is mispricing the possibility of a positive outcome to Spain’s current crisis.
The first argument relates to the magic of the number seven, at least in regard to Spanish 10-year bond yields. Commentators frequently repeat the wisdom that once a country’s sovereign bond yield crosses that threshold it has entered territory deemed “unsustainable”.
But even under a very stressed scenario – in which Spain has to fulfil all its €200bn-€220bn financing needs until 2014 at yields of 8-9 per cent – the impact on the average interest rate of its outstanding debt would be a rise from the current 4.1 per cent to about 5 per cent. While painful, this should not be fatal. It is certainly not “unsustainable”.
A second myth about Spain’s economy is that it is being suffocated by huge levels of private debt. Spain, we are told, entered the crisis with healthy public accounts compared to its European neighbours, with debt to gross domestic product standing at below 60 per cent, but with private sector debt above 200 per cent of output.
Too often the nature of this debt is misunderstood. The bulk of this non-financial sector debt was used by companies over the past decade to make investments in fast-growing emerging markets across Latin America, eastern Europe or Asia.
A fact often overlooked by the market is that the value of these foreign assets today is comfortably higher than their outstanding debts, leaving a net positive external balance for Spanish companies.
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A third piece of wisdom too readily accepted as gospel is the Spanish economy’s inability to find a source of growth. While true that domestic demand is still falling, little attention has been given to the fact it is being replaced by rapidly increasing exports. In the first months of 2012 exports of goods and services reached the highest level on record.
Fourth on the list is the idea that Spain has suffered a significant loss of competitiveness since the introduction of the euro and cannot adjust given the inability to devalue its currency. However, competitiveness is rising quickly. Nominal wage restraint, combined with improvements in hourly productivity, are driving a significant decrease in unit labour costs.
Finally, the markets are fearful of the debts of Spain’s 17 autonomous regions and the seeming inability of central government to rein in their spending. Yet regional debts amount to a manageable 13 per cent of GDP and it is overlooked that this has already been fully accounted for in the reported figures of total national debt. Commentary about aid to the most indebted regions – such as Catalonia or Valencia – to refinance their “old debt”, forgets that such aid would add nothing to Spain’s existing total public indebtedness.
Spain’s central government has almost full control over the amount transferred to the so-called autonomous regions, with the exceptions only of Navarre and the Basque Country. While we will continue to see domestic political disagreements over efforts to reduce spending among the regions, central government ultimately has control over the money that is allocated.
Of course, none of this will matter if Spain struggles to find enough liquidity to see the full benefits of its structural reforms. Then there are the wider political factors that are causing uncertainty over the immediate future of Spain.
But markets are still mispricing the potential of the Spanish economy and have missed its export-led private sector performance and the speed with which it has adjusted its current account balance.
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Investors cannot be accused of treating Spain “unfairly” but they can be accused of failing to be sufficiently sceptical of what the market is telling them. For those that can think for themselves, there will be significant opportunities.
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The writers are respectively the People’s party spokesman on foreign affairs and a Fulbright scholar at Harvard University
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Copyright The Financial Times Limited 2012.
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