Last week Spain delivered two key elements to anchor credibility: the banking stress test and the budget. Even if it achieved a fair result on both pending issues, it faces a lot of hard work ahead to fully recover investors’ confidence.
The banking test seems extremely demanding, as capital needs were tailored following a doomsday adverse scenario involving a 6% GDP drop over the period 2012-2014. Bad loans were reckoned to grow as much as 85% in real estate, 27% in corporate and 15% in residential mortgages. A catastrophic outlay that surprisingly only induced few casualties.
One might be led to believe Spanish banking enjoys an enviable resilience. And yet closely examining the figures you come to the conclusion that such an outcome is likely to materialise under normal circumstances. Stress tests are well known for picturing extremely nasty prospect while turning out rather benign levels of additional capital.
The really adverse scenario is the one banks will face should growth continue its downwards slide. With no recovery at bay, balance sheets will rapidly deteriorate through the combined pressure of dwindling margins and increasing losses.
Oliver Wyman might have performed a sharp job in identifying bad loans. But it has largely bloated the potential benefits to be reaped in such an adverse scenario. Even if recession does not go deeper that expected today, it will dent margins at a quicker pace than the harsh stress test imagines. Banking solvency will thus fully depend on growth.
Much the same can be said about the budget. It has been stretched to suit a marginal situation where growth is supposed to take place next year over the last couple of quarters. This rather optimistic assumption is further reinforced by predicting a level of income that goes beyond what might be reasonably accounted for even allowing such growth scenario to be achieved.
The budget lacks any room of manoeuvre in case things might turn worse than expected. To make things less plausible, no structural adjustment is envisaged. Thus, squaring the accounts will force government to implement hasty cuts and tax increases further depressing economic activity and dampening prospects to balance the budget.
A number of measures to enhance competitiveness have been announced. But they seem largely insufficient to redress the situation. Should growth fail to emerge next year, both the budget and the financial reform might be unable to meet their targets.
Rescue might help to sort out this messy outcome by bringing down financing costs to the private sector and helping to recover confidence. Spain might not need money right away, but it desperately needs to curb risk premium and the credit crunch most enterprises face right now.
