In sharp contrast to Greece, it is difficult to be too critical of the intentions of politicians on the Iberian Peninsula. Portuguese Prime Minister Pedro Passos Coelho has implemented significant austerity measures designed to lower the budget deficit to 4% of GDP this year, against the headwind of another deep recession, and debt-to-GDP is expected to stabilise at around 112% in 2013. He has also vowed to undertake a second round of asset sales, reinforcing his commitment to fiscal prudence.
Unfortunately, after S&P’s recent decision to chop Portugal’s credit rating to below investment grade, numerous banks and real money managers were forced to sell their exposure to Portuguese debt. This resulted in a very sharp sell-off in Portuguese debt, with the 10yr yield reaching 18.4% earlier this week, now 14.7%. It could be argued that investors in Portugal are over-reacting; because of last year’s EUR 78bln rescue, Portugal is basically funded until the end of next year.
Likewise in Spain, PM Rajoy is focused on reducing debt and deficits as well as implementing much-needed structural change. In a bold move yesterday, Economy Minister de Guindos announced that banks would be given a further year to write down their bad real-estate loans if they agree to merge by May. They would also gain access to the government’s bailout facility. De Guindos stated that banks would be forced to raise provision on loans for urban and rural land to 80%, from 31% currently. Although this announcement will not affect the budget deficit, it will raise debt because the Spanish treasury will need to issue bonds so that the equity in the bank bailout fund can be raised to EUR 15bln from EUR 9bln.
Together with Italy, Spain has been given the benefit of the doubt over recent weeks, no doubt helped by the ECB’s generous 3yr LTRO. Two months back the 10yr yield was up at 6.75% whereas today it is below 5%, the lowest since November 2010. For a no-growth economy, a 5% yield is still too high. However, it is clear that some investors and banks have been prepared to dip their toes into Spanish bonds over recent weeks. Financial conditions on the Iberian Peninsula remain extremely fragile. Just possibly, however, there may be a light flickering down the tunnel.