¡Ay, caramba! With Spain falling into recession, talks of it needing a bailout have gotten louder. It was reported that the country’s Q1 2012 GDP matched its previous reading for Q4 2011 and printed at -0.3%.
Let’s take a look at some of the facts, shall we?
Fragile property markets
Ireland’s primary sore spot was the bad commercial property loans that forced the government to launch a series of recapitalizations. For Spain, investors are worried about how there are barely any provisions to safeguard banks from losses on residential mortgages.
If unemployment continues to rise and approach 25%, more people won’t be able to pay for their mortgages and defaults would pile up. Yikes!
To be fair, the Spanish government has taken measures to clean up its banks from dud loans. However, the question is, just how much bad debt can the government pay for?
Economic gurus are worried that many banks will need to be bailed out and the government will have to ask the Troika for money to pay for them.
Austerity weigh on growth
In Spain, the budget deficit has skyrocketed to almost a tenth of its GDP in 2011. As a result, the European Council has been compelling Spain to take on harsh austerity measures to reduce the deficit to 5.3% for this year and 3% for 2013.
Austerity, in the most basic sense, is the act of rigorous saving. It isn’t necessarily a bad thing, but when it is implemented during a time of negative growth, economic recovery could end up being choked off.
This is what happened with Ireland that could happen to Spain too. In Spain, tough austerity measures have been employed that have forced commercial banks, big companies, and even households to fix their balance sheets.
Extremely low investor confidence
In Ireland, one of its main goals before it had to ask for a bailout was to restore investor confidence. Unfortunately, Ireland never succeeded, as investors never saw that the Irish government was serious about their fiscal sustainability despite all their fiscal adjustment plans.
Spain seems to be heading the same direction. Last month, Spanish bonds soared to almost 6%. In order to quell investor fear, the Spanish government publicized that they were able to save an additional 10 billion EUR.
It not only failed to work but it actually eroded investor confidence. Investors became worried about the implication of the savings on economic growth, which resulted in Spanish bond yields moving even higher.
Will Spain follow Ireland’s footsteps?
If the Spanish government is unable to regain the market’s confidence, then I suspect we’ll see the same bailout scenario occur. I’m extremely worried for the mere fact that Spain isn’t Ireland. Spain is gargantuan compared to Ireland and bailing it out will have some serious negative ramifications in the economic situation of not only Europe but the rest of the world as well.