Does Spain Have The Flu?

Rating cuts would hurt Spain more than Portugal

(Reuters) - A Spanish ratings cut may hit government bond markets harder than the recent salvo of downgrades on Portugal because, unlike its neighbor, Spain is seen capable of escaping without an international bailout.

Fitch gradually slashed Portugal's sovereign credit rating by five notches over the two weeks after the Portuguese government collapsed on March 23. Other agencies downgraded Portugal but the market reaction was muted, raising questions over whether the ratings firms are behind the curve.

But analysts caution that Spain is in a wholly different position and that a change in the external view of its creditworthiness would have a negative impact.

"But another Spanish downgrade within the next four to six weeks would not be something that the market is factoring in. If Spain were to be downgraded it would almost certainly renew contagion fears ... and the fact they may still be A+ (potentially after a downgrade) is not necessarily a shield."

Russell Silberston, head of global interest rates at Investec Asset Management, which manages fixed income assets worth $29 billion, said he was waiting for "clear progress in deficit reduction" before he takes on exposure to Spain again.

"While we just wouldn't think about Greece and Ireland and Portugal, for Spain we have contacts there, we speak to companies and investors," he said. "(But) we are just looking more closely, we haven't bought it yet."

Comments:

The Spanish Debt Flu might be an appropriate title to describe the developing situation in Spain.
Sovereign debt has reached very high levels, and the ability to raise taxes has diminished due to high unemployment levels and the massive mis-allocation of capital in unneeded housing stock.
Though markets may expect that the Spanish situation is not as serious as that of Portugal, my analysis indicates that Spain is not only in just as much trouble, but is beyond the ability of the EU to bailout.

A few facts about Spain:

GDP $1.374 Trillion (2010)

Population 46,000,000 (2010)

Unemployment rate 20.4% (2011)

Budget deficit 9.4% of GDP

Debt to GDP 72% projected for 2011 (up from 53% in 2009)

With an unemployment rate of over 20% it will not take Spain long to cross the critical 80% debt to GDP threshold aka the point of no return.
Severe austerity could be one option, but is unlikely to be implemented due to extreme unpopularity with a public that is already suffering.
Sovereign debt default is the mostly likely scenario in the next 1 to 2 years.

At some point, perhaps this summer or autumn, I anticipate the bond market will start to punish Spain with higher interest rates which will exacerbate the problem.  The contagion is likely to spread across Europe and is a likely trigger for the sovereign debt crisis we have discussed previously.  The US dollar will likely benefit in this scenario despite Americas own problems, it is the least ugly in this fiat currency backwards beauty contest.