Research (ČP Invest)
Investor's window  |  November 07, 2012 10:57:05

Spain: Where nothing not even death does not

Spain declining tax revenues, but crossed out public spending is constrained, therefore increasing returns Spanish bonds. Way out of this situation is to increase competitiveness - reducing wages or investments in education and technology.

O AfterGreece, the media shifted to problems in Spain. Every day we are inundated with information about the current state of negotiations Spaniards and the rest of the euro area, the IMF and the ECB on any financial assistance. To be in it but a little confessing, let's see why it is actually talking about Spain and which has its own internal problems and what's bothering him. One of the main problems is now insolvent banks. Spanish banks have provided in the past, too many risky loans, mainly for the construction of houses on the Spanish coast. It was at a time when real estate prices were abnormally high against the long-term average. The real estate market was thus bubble (too high price of real estate). During the financial crisis in 2008 and 2009, the bubble burst. Property prices have begun to fall, and developers have been able to pay its obligations to the banks.Banks thus accumulated on the balance sheets of loans outstanding. To unraveling the Spanish financial system and the central bank began to slowly bank bailouts. However, with the declining performance of the economy came in lower tax collection, while there has been increased public spending (social area - unemployment benefits, etc.) to Spain deepened its deficit and debt. With the decline of the economy also continued falling property prices and the volume of outstanding loans are still increasing. Therefore, Spain could not afford another bank bailout from public sources. First, it did not and the problem is still growing. Therefore hit European Union, which promised to help Spanish banks amounting to 100 billion euros.The Spanish government had to adopt banking reform, whose main part is to remove banks from bad loans and toxic assets using the so-called bad bank (Consolidation Bank). Consolidation Bank takes over from commercial bank loans outstanding and particularly toxic real estate assets, which lost most of its value. Asset prices the transfer will determine the Spanish central bank in such a way that the new institution was during his tenure (10-15 years horizon) profit.

Another major problem is the high unemployment associated with increased central and local debts.Unemployment is around twenty-five percent and unemployment among young people (aged under 26) is even more than fifty percent. Among other things, sows the seeds of future social problems with so-called lost generation.  

The Spanish economy is in deep recession. The economic downturn is due to previous bad investments, especially in the real estate sector. The performance of the Spanish economy and adversely hit by the common European currency. Labour productivity in the last twelve years has risen by seven percent. If we look to Germany, so there for the same period labor productivity increased by 32 percent.Growth of real wages in both countries is approximately similar. Therefore, for the last twelve years has become the Spanish manufacturing sector and the service sector uncompetitive (eg car maker SEAT brand is facing bankruptcy). Previously, the smoothing was free movement of foreign exchange rates. In this case, the Spanish peso weakened against the deutsche mark would be offset by faster growth of German productivity. However, the introduction of the common currency this mechanism stopped working, and therefore in the euro area countries with lower productivity growth rate were / are and will lag behind those with a higher rate of productivity growth.

Let's look at the fiscal solvency of Spain. To the solvent, and thus yields grown government bonds, so long Spain needs to meet the following formula:

budget surplus x ? public debt (long-term bond yields - dl. nominal GDP growth)

Therefore, Spain desperately trying crossed out on public spending and tax increases. It seeks to achieve a higher budgetary surplus respectively. lower the budget deficit. But the right side of the formula is relentless. Spain's nominal GDP growth is negative (recession), which increases the value in brackets, and thus the entire right side of the formula. GDP growth will not support nor government cuts and tax increases - on the contrary rather will act negatively. So raising the left side of the formula (cuts and tax collection) to compensate for the lower GDP on the right side of the formula. This does not mean that the government should not implement cuts to public spending. Primarily, the government (as well as any other entity) do not get into a situation where the above formula is not sustainable.

On the one hand, therefore, we have a declining tax revenues and public spending crossed out. However, tax revenues are falling at a faster pace than public cuts. This public budgets get into a debt spiral. Therefore grows right formula - specifically, the total public debt. This is the cause of growth yields of Spanish bonds. Regional and central government so the market has to borrow more and more money, but investors demand higher interest rates (again, there is an increase in the right side of the formula). Some regions are doing so badly that short-term bond yields exceed twenty percent. Thus, funding is possible long. Therefore, some regions have asked the central government for financial assistance than to so dearly market loans.In January of this year as the first asked for help Valencia. Then followed the Murcia region and are now talking about the largest region - about Catalonia, which accounts for about a fifth of economic performance.

Government bonds would explode at the moment, if the European Central Bank was not involved. Therefore, Mario Draghi (ECB boss) claims that the ECB will do anything to save the euro. Draghi wants to buy an unlimited amount of Spanish debt and thus reduce long-term bond yields Spanish. It is now the only way to keep Spain at least in the short term over the water.And it's also the only way at the moment to reduce the right side of the formula without Spain declared bankruptcy and default on part or all of their debt.

Even if you imagine that Spain officially ask the European Union for financial assistance and the ECB to start buying their bonds, so we understatement there remains the question of whether in the long run in Spain will be able to meet the above formula. The European Central Bank may hold Spanish yields artificially low, but other components of the formula should contribute to meeting the formula. And here is the key to the competitiveness of the Spanish economy.When will be competitive, and Spanish firms will produce more. They start to hire more employees. Will flow into the state treasury more money both from direct taxes (eg income tax) and from indirect taxes (eg VAT) and even at a lower level of taxation that does not burden the private sector as much. This will make it less unemployed, thereby also facilitate social public expenditure. Spain will be able to eventually achieve budget surpluses or deficits are not so high (right side of the formula will be OK). Public debt will decrease, increase nominal GDP (right side of the formula will improve slowly). This will have an impact on bond yields, which even without the support of the ECB will decline.

But she is the key competitiveness of Spain. How to achieve it? There are several ways. The first example is the reduction in wages - politically and socially unacceptable. The second way is long-term investments in education and technology, thereby increasing productivity. But who will invest in Spain now, and this is mainly for the long haul. Spain, but now "quenches" the problem in the short to medium term. Long-term investments will flow to Spain till the system changes in the public sector and the country will be narrowed to such indebtedness. Another way of achieving competitiveness devaluation of the local currency, which was a standard process before the introduction of the euro.  

I believe that European politicians and central bankers will try to rescue Spain at any price - that we see today. Short-term success will be their policy, what is not bankrupt Spain concerns. But the economic benefits will be minimal for Spain, because purchases of Spanish bonds does not solve the competitiveness of Spain. In the medium term will inevitably have to come to debt restructuring (as in the case of Greece), which is another word for bankruptcy.The question is whether Spaniards declare bankruptcy and leave the Eurozone or the funding it will be so expensive for the rest of the eurozone, the euro area itself ends financial aid, exclude Spain from the euro zone and sends it as insolvent.

The best solution is the fastest possible exit from the eurozone. And not only for Spain but also for other countries in the periphery. Departure will be painful - but the short term. If there is a devaluation of local currencies and a decline in living standards. And this at a level commensurate with their economic performance.In the long run, however, the economy becomes competitive because of currency devaluation. Competitiveness is therefore sensible way out of the current situation. Remain in the euro zone will hurt less, but permanent. There will be slow "digestion" and eventually the country gets into a state where the economy will be totally destroyed. You will then apply the proverb "where there is nothing, not even death does not."

  Written for the company Broker Consulting

Michal Valentík

Michal Valentík

Působil jako senior makléř a proprietary trader, nyní je hlavním investičním stratégem investiční společnosti ČP INVEST. Vystudoval VŠE v Praze se specializací na finance a ekonomické teorie. Absolvoval stáže na Hongkong University of Science and Technology a Friedrich-Alexander Universität Erlangen-Nürnberg. Ve svých článcích a analýzách se zabývá především aktuálním vývojem na kapitálových trzích, investováním a ekonomickými teoriemi. Ve volném čase se věnuje horolezectví.

Logo ČP INVESTČP INVEST investiční společnost, a. s., je spolu s mateřskou Českou pojišťovnou, a. s. součástí mezinárodního finanční skupiny Generali PPF Holding B.V., která působí ve 14 zemích střední a východní Evropy, kde poskytuje služby více než 13 miliónům klientům a spravuje aktiva ve výši přes 15 miliard euro.

ČP INVEST poskytuje služby v oblasti kolektivního investování. Základní nabídku investorům tvoří 12 podílových fondů ČP INVEST vedených v CZK, které jsou projektovány pro široké spektrum klientů. ČP INVEST je zároveň celosvětově výhradním distributorem EUR fondů Generali PPF Invest. Správa portfólií fondů ČP INVEST i Generali PPF Invest byla svěřena společnosti Generali PPF Asset Management, která disponuje velmi silným analytickým zázemím a je největším správcem investic v České republice.

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