Spain’s debt trap

Government roughly owes 60% GDP to foreign residents, while private external debt runs at twice and a half that figure. Spain faces an awesome debt trap that curtails its economic performance. Trimming down public deficits fails to reverse hastily increasing financial obligations while enterprises’ deleverage efforts have so far delivered rather scanty results. No wonder the IMF is ringing the alarm bell.

Current imbalances are gradually being checked. But stock gaps can only be redressed over the long run. The sizeable cumulated amount due might take a full decade being blotted out. Meanwhile financial burden will weigh heavily on corporate profits and the ability to finance new investment. Frantic attempts to further reduce wages and trim labour costs are closely linked to sky-scraping indebtedness. While this move helps to alleviate the competitive gap, it depresses home demand and ruins prospects of fostering growth.

Premium risk is markedly being subdued as ECB tough stance has quelled prospects of a Euro implosion. Yet, further improvements seem rather implausible to achieve so long as debt levels continue to spook investors.

It’s hard to figure out how to deal with indebtedness without paying a high tribute for past profligacy. Only high nominal GDP increases could perform that trick. But low inflation and a skimpy growth outlook flatly fail to deliver such a helping hand. Spain is bound to undergo a prolonged adjustment before escaping from the current debt trap.

While many companies have downsized their exposure at the price of sacrificing earnings or selling assets and business lines, most are compelled to refinance their liabilities. Thus, further risks are transferred to financial institutions. So far as interest rates edge close to their current historically low levels, banking solvency will only suffer limited damage. But should credit conditions sharply stiffen in future, massive defaults might ensue. The IMF concern seems fully warranted for all the fuss raised in Spain about such a grim prospect.

About the Author

JP Marin Arrese
Juan Pedro Marín Arrese is a Madrid-based economic analyst and observer. He regularly publishes articles in the Spanish leading financial newspaper 'Expansión'.

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