Category Archives: Spain

Spain

The day after the Spanish bailout: internal default

Global Economy, On the cover, Sin categoría, Spain

“The Spain bailout is the one they do not want to ask for and the one nobody really wants to give”The “Spanish Bailout”…  Wrong term. No rescue for Spain, but the rescue of the Spanish state and its political spending, which is very different.

I spent a few days in Madrid and I checked again that our politicians have a wrong perception, extremely optimistic actually, of bond markets. The first, and widespread, it that access to credit or the ECB is unlimited, forgetting that behind it all there is always private money. The second is to think that the bailout will attract investors driven by the ECB heat . Except for a few hedge funds in the very short term, not much. Would you give money to a troubled boy who depends on his father’s pay to live yet his parent threatens to take it away if he misbehaves again?

The biggest risk that investors in bonds perceive is that Spain depends on an ECB support signed by some countries whose citizens do not want more bailouts. Additionally, the market is negatively surprised by the credit ratios of our country, which is already on the verge of reviewing its 2012 deficit target again, to a 7 to 7.2%. And as much as exports improve, they do not offset the effect of four consecutive years with deficits of 7% to 10%, some 350 billion of accumulated deficit since 2008. If we add the future maturing debt, which totals 500 billion in the next four years, the over-supply of Spanish bonds compared with the investor’s ability to absorb more sovereign risk is simply unaffordable .

With the risk premium below 390 basis points and the yield on the benchmark 10-year at 5.75%, we have witnessed the euphoria … of the state. The spending bubble is guaranteed, Draghi supports it. Meanwhile, companies continue to see credit diminishing, and when they receive lending, it is with rates up to 350 basis points higher than the cronyism corporate zombies. And in this process of mummification of the real economy, it is not surprising that non-performing loans of banks reach a 10, 5% and have risen to 178.6 billion euros.

The question is not whether or not there will be a bailout. Unfortunately it is only a matter of time. The question is what will happen the next day.

  • Whatever Standard & Poors or Moody’s say, a bailout is the realization of the impossibility of free market finance. Therefore at the time the ECB purchases the first bond, bailout is similar to ” default “. That is known by our politicians and businesses.Using high-level political pressure to avoid junk bond rating before the election is only kicking the can forward. The Moody’s report is very clear. Without bailout Spain would not be ” investment grade ” , ie an independent country that does not satisfy the solvency and liquidity requirements.
  • Absolute dependence on ECB: The day after the bailout Spain is an intervened state. Well, even more intervened. Fans of the “Icelandic solution” will be rewarded with their dream, being a country controlled and handcuffed (by the Troika in this case). The Spanish bailout is the one that nobody wants to give and no one wants to ask for. Nobody wants to concede it because ” once you pop there is no stop “. Spain would rely on the ECB to ensure its economic viability, but also would fall under the scrutiny of that entity that would examine monthly the country’s accounts to see how we go. If you think that there have been cuts in Spain so far, you are wrong. They really come the day after the bailout.
  • Companies have the greatest difficulty. The “crowding out ” effect of the bailout implies that, again, access to credit is restricted to companies that are left  the few crumbs of credit from European countries that have increased their debt by 3 trillion euros since 2002, and intend to continue. With refinancing needs of European private companies, which create jobs, of a trillion through 2015, it will be a race between predator states, banks deleveraging and companies, in the middle, suffering higher taxes, more interventionism and less credit.

When a country’s solvency, as shown in the graph below, depends entirely on the salvation of the ECB, the risk extends, it is not mitigated. And it’s amazing that, despite the promises of unlimited support, Spain’s solvency is valued at very low levels.

The risks of the next day of the bailout are:

The greater fool theory, and the German plan

Let me tell you what the market calls “greater fool theory.” It is the popular way to try to influence the price of an asset by saying that “someone”-preferably far away and unable to disprove, as “the Chinese” or “the Russians “- is coming, to try to” convince ” investors to buy. Indeed, it sometimes works. Between 2005 and 2009, half of the Ibex was a “greater fool theory ” driven by media rumours of “they tell me for a fact that Chinese will buy it. ” But it works only for a while and then investors learn not to believe the rumors. What happens now with the ECB, which has not bought a single Spanish bond, is similar. And the problem is that they expect it to work.

The German plan, is that, as they do not trust their partners, they want more or less in the middle of 2013 that the outstanding debt held by local investors of problematic countries is at least 85%, preferably 100%. When the debt of Spain and other countries is in domestic hands, the problem and the risk of default and contagion is not European or global, but local and, therefore, countries will have to take good care of breaching their commitments, because the effects of the default fall on the population – internal default-, given that Spain has its social security, pensions and private plans more than 80-90% invested in local public debt.

When they say that Spain would ask for the bailout but not use it, they assume that only the threat of Draghi actions will force international investors to buy Spanish bonds. I don’t see it. If the ECB forces the maximum risk premium relative to the Bund to 200 basis points, as they say, it  will provide the hilarious situation where Italy has to contribute 1.5% of their GDP to the bailout with its own cost of debt at higher levels. Donation?. Then we will have to do the same for Italy and it becomes a pyramid scheme. To infinity and beyond.

Virtual Bailout is a myth
There is no “soft” or “virtual” bailout, limited conditionality, temporary liquidity or any adjective you want to invent.

It is a mortgage and the mortgage cost. And when the country depends on the ECB, once it buys the first bond, the state is mortgaged for life. Unless we curtail public spending that neither Hollande, nor our politicians want to cut. The cuts will come to the big items: pensions and unemployment. No. exports are not going to save us when public debt is 110% of GDP.Private debt … Very publicFor investors, the tales of “debt accounted for deficit purposes” and gimmicks to account less real indebtedness do not matter. Here what counts is all debt and all that is guaranteed by the state. It might be repeated again and again, but it’s a lie, that “private debt is the problem.” Not so. Public debt is our problem. There is no demand and that is why we have to ask for a bailout. And in no small part because a large portion of the debt misnamed as “private” are unpaid bills, guarantees and government IOUs, debt of public companies … none of them counted as “excessive deficit”. But debt nonetheless. Taking into account all financial liabilities issued by the public sector, Spain’s public debt exceeds one trillion euros. And if you add endorsements and guarantees, more … see the chart below.

Illegitimate debt. Ecuador without oil

There are parties in Spain that call for an “audit” of the public debt-default-, deem it as illegitimate -default-and restructure-default-.  Calling “illegitimate debt” to those commitments that have been generated under a democracy and especially between 2008 and 2011 with the approval of each of the parties and unions is surprising to say the least. But above all, they are all living in the land of the unicorns if they think default will impact on future access to credit, on the risk premium and the “social rights of citizens.”

If Spain defaults, we will see the collapse in unison of the Social Security and Pension Funds, invested up to their 90% limit on sovereign debt. And we would see the crisis extend an average of three years, and a drop of 7% of GDP ( Cost of sovereign default, De Paoli, Hoggarth and Saporta ). But above all, when I hear the comments about other countries that have declared illegitimate their debt there is a small point they tend to forget. Almost all countries that have survived these restructurings were oil-rich countries. We want to be Ecuador, but with no oil. And, of course, without its risk premium. And of course, without the credit restrictions of Ecuador. With abundant, cheap credit that we can declare illegitimate again in 2020 and move on. A joke.

Accumulation of debt is not growth

While we see in Spain demonstrations demanding more debt and more spending, and call for policies “of more deficit to grow,” I dare to leave proof that debt is not growth. The graph below, from the study ” A decade of debt (Carmen Reinhart & Kenneth Rogoff, courtesy Peterson Institute) shows that the countries in advanced and emerging economies that have grown the most in GDP per capita have been those that have less debt to GDP (less 30%).I fear that the day after the bailout  the problems will be the same, budget cuts will still be needed and  excessive borrowing will remain. But by then, in a few months, we will not be a problem of global contagion. Our excesses and waste, our debt and its consequences will be our own problem. And investors will continue to prefer buying corporate bonds, that “evil” private debt, before buying government debt of a state on the brink of insolvency. A success.

Spain is not Enron, but the risks exist

Global Economy, On the cover, Sin categoría, Spain
This article was published in El Confidencial on October 6th 2012

“Spain is not Uganda, it is Enron” Christopher Mahoney

“Spain will not grow for the next five to ten years” Sean Egan

sovereign downgrades

One of the most dangerous problems in Spain today is to reject the international analysis about the country’s difficulties as malicious. The market is very concerned about Spain today, but if the steps to resolve the debt crisis are not taken, Spain could quickly go from a cause of concern to being ignored.

We cannot say it was a successful week for the “Spain brand”. The country was mentioned as an example of hypertrophied government size in the Romney-Obama debate, the EU is wary of the deficit targets for 2012 and 2013, and the country gets compared with Enron. I do not like it, it hurts my pride, but we must pay attention.

The continuous fluctuations and messages about the request or a bailout are not accidental. The reality is that it is impossible to rescue Spain. It would cost a trillion euros, according to estimates by Moody’s and Egan Jones, and governments have to find ways to avoid the impact on the Eurozone.

regions add 18
The meeting of the presidents of Spain’s regional governments was an example of “trainwreck” for many investors. There was talk of compromise, but more importantly, of “sharing the deficit”-more debt, unconditional support -more debt- and “growth policy”-more debt. There were no talks of political spending cuts, just trying to increase the deficit. When talking of deficit read “losses” and read more taxes.
This is what we must avoid. Chris Mahoney thinks the country has more than a debt problem, but, just like Enron, Spain has a huge dependence on credit, and without credit its GDP mirage fades. Mahoney says that Spain depends on “a positive image” to continue to access more debt. Spain, according to Mahoney, needs to create the illusion of future growth to attract more debt to keep the illusion of wealth and to continue creating a debt snowball.
I disagree. The scheme of eternal debt is widespread across the OECD, except that in Spain we took the party by storm and the hangover will be tougher.
Spain is not Enron. It can stop the snowball of debt in a week cutting wasteful spend. In the debate between Romney and Obama Spain had the dubious honour of being signalled as an example of bloated government spending, but unlike other countries, its massive expenditures could be cut immediately given the enormous size of subsidies, 1.4% of GDP.
Enron could not cut debt because its assets simply did not exist. In Spain the private debt of the country, which is huge, is supported by assets, which could be better or worse but sellable, and as such, debt can be reduced with divestments and capital.
The risk is not being Enron, but to be perceived as a kind of Rumasa –the industrial Ponzi-scheme created by Mr Ruiz Mateos in the 70s- a huge web of opaque cross-holdings between state, banks, and companies to hide debt and pump up asset values between close friends and cronyism. This is only solved with more foreign investment, opening the market.
capital flight
Why do they doubt that Spain will grow again?

When Sean Egan warns that Spain will not grow for five or ten years, what he analyses is the inability to generate industrial demand and investment with such a monstrous debt and a huge tax burden. If we maintain a confiscatory tax policy, legal uncertainty and the bloated weight of the government, he could be right. Considering that Spain is an ultra-cyclical economy, it could also recover quickly if the burden of taxes and government is reduced. Let’s face it, exports are improving and foreign investment rebounded slightly, although it’s nothing to get excited. Most of the deleveraging is not completed, because the reduction of public and private debt has not yet really begun aggressively.

Investors and analysts warn that the problem in Spain is the increasing burden of financial commitments without demands.

Egan Jones downgraded Spain last week. They cite as most important elements of its downgrade the pace of industrial demand destruction, and the debt overload of the regional and bank bailouts. Let’s remember that when the year started the capital needs of banks were supposed to be a maximum of €40 billion and now the official figure has risen to €60 billion, while many analysts assume capital needs of €200 billion.

Bailout after bailout

The problem is that in the vicious cycle savings banks-state-regions-spending-debt there is never a bankruptcy, no credit responsibility and, therefore, a perverse incentive for mismanagement.

I see that the bond market, taking advantage of the Draghi effect, is trying to accumulate five-year Spanish credit default swaps, although the volume is still small. Investors perceive the following problems that could cost up to 60 billion more than expected in 2013, bringing the deficit close to 6%, well above targets:

* Giving full and unconditional support to the regions. The regions have already consumed almost all of the Liquidity Fund available to them, with extremely mild conditions. The government says that the state could intervene the regions if they don’t comply with the targets. Let us see what government dares to intervene Valencia or Catalonia.

The regions have an outstanding debt €191 billion, 18% of Spain’s GDP. All guaranteed by the state. Having the state as guarantor creates perverse incentives. Regions are bailed out but no one dares to intervene them, and even if this happens, the taxpayer pays the bill any way. The autonomous communities complain that their individual deficit is very low. Remember: deficit = loss = more taxes. They account together for 33% of the total Spanish deficit.

* Unconditional support to bankrupt savings banks. The Spanish banking system balance sheet is 340% of the country’s GDP and, moreover, is extremely exposed to sovereign debt. With non-performing loans of 9%, and the drop in deposits it is likely that we will see another round of “bailouts” in 2013.

* The “bad bank” will buy real estate assets not with enough discount, at”economic value”, that is, betting that the long term everything will go up. This will require an injection of public capital to support the bank’s finances. And the longer it takes to sell, more public capital injections will be needed. All this is done to “get credit flowing” to the real economy. However, banks cannot recapitalize themselves as requested by the EU and at the same time provide credit to a “real economy” that sees increasing taxes and decreasing margins. That’s like blowing and slurping.

European CDS against Spain. Crazy
The European Union is greatly concerned. They doubt Spain will comply with the deficit targets in 2012 and 2013. The IMF believes that Spain will not reach a 3% deficit until 2017. The EU is so concerned that after criticizing Credit Default Swaps for years, and given the magnitude of the potential problem, between 700 billion and one trillion euros, the EU itself and the ECB are considering issuing European credit default swaps for the Spanish rescue, according to Bloomberg .

This is a recipe for disaster, because it shows that the EU itself is wary of the ability to repay debt of Spain and seeks to attract foreign investors to finance the bailout, insuring against a default of Spain. What happens? That CDS overshoot, which spill over to the sovereign debt but also to the debt of European Stability Mechanism (ESM).

A debt problem is not solved by more debt. If Spain stops the bailouts and establishes unquestionable credit responsibility, negative surprises are likely to be decreased greatly. A further delay in the deleveraging process from the expenditure side will mean a longer path to recovery and revenue growth. But it seems it does not matter. Someone will pay the debt. Some day.

My comments to CNBC here: “We have a lot of earnings downgrades to come and an environment where companies need to reduce their debt significantly”

http://www.elconfidencial.com/encuentros-digitales/daniel-lacalle-26

Spain’s 2013 Budget Needs Red Pencil Slash

Global Economy, On the cover, Sin categoría, Spain

This article was published in El Confidencial on Sept 29th 2012

“Deficits mean future tax increases, and politicians who create deficits are tax hikers”, Ron Paul

Spanish 10 year bond yields remain stubbornly at 5.85% while spreads widened to 450 basis points after the announcement of a budget that provides more questions than answers.This week El Confidencial published that the Spanish Government restated the 2011 budget deficit from 8.6% to 9.44% and 2012 could slip to 7.4% from the current 6.3% target. We talk constantly of regaining market confidence, but such confidence is not going to come with constant budget revisions. It will be achieved with better than expected numbers. This is the reason why I am concerned about optimistic assumptions in the budget and aggressive tax increases added to generosity in maintaining a bloated state. I mentioned a few months ago that Spain needs to apply the red pencil throughout a bloated state that spends, even in alleged “austerity times” the same funds as in the peak of the housing bubble (see here).

Spain will have to borrow around 200bn euro in 2013. That is 567 million euro per day.

The 2013 Budget is a step, but an insufficient one

Spain’s Economy Minister, Mr Montoro, said that “it is impossible that Spain has lost 70 billion euro in revenues only due to the crisis.” With the number of companies in business falling from 155,000 to 135,000, the real estate bubble bursting from 650,000 homes built per year to 150,000, the collapse of the industrial activity of 2% per annum and the rise in unemployment to 24%, I think it is admirable that revenues have only fallen by 70 bn euro.

While economic measures focus in recovering lost revenues of the housing bubble that will not return, the investor perceives that Spain could forget about the medium-term risks of a predatory fiscal policy.

Voracity in tax collection with possible impact in the medium term
Almost half of the budget adjustment is, again, tax increases that reduce consumption,weaken the economy and prevent companies from creating jobs.

In a recent analysis, JP Morgan warned about a few key aspects: loss of deposits, industrial decline, poor profit margins and stagflation. The loss of deposits is less than what is estimated in the press, announcing almost 120 billion, but we should never underestimate 30 billion as “irrelevant”.

However, in Spain between 1500-2000 companies file for bankruptcy each quarter. In addition, the CPI soars to 3.5% when GDP decreases 1%. This risk of “stagflation” -inflation with recession- can be very dangerous for the economy. All this happens in an environment where profit margins have decreased to make many of the large companies and SMEs generate margins below cost of capital. The economy remains extremely rigid and tax increases are reflected in the prices immediately. Adding an unemployment rate of 24% to the equation creates a difficult horizon for recovery.

While the general government deficit remains a concern, we must also highlight the positive , and in July there was a current account surplus of 500 million euro. This is important because, if confirmed as sustainable, it implies that Spain reduces its external financial dependence .

We must appreciate it, but we must not forget that it is, in part, the result of the inability to continue to import due to falling industrial demand. Spain is still not competitive and structural reforms must stem the drain on companies, rigidity and erosion of profit margins inflicted by aggressive tax increases.

If companies are not created, if SMEs do not generate profits, then banks do not finance, debt increases, tax revenues collapse … and deteriorated companies do not hire…and the unemployed do not consume.

If we prevent businesses and citizens from becoming richer, we impoverish the country 

Goldman Sachs called the 2013 budget “Running to Stand Still” referring to the U2 song about drug addiction. The market is concerned about optimistic tax revenue expectations (+4.4%) and estimates of increase in social security contributions that are inconsistent with the government’s own estimates of unemployment increase. The market sees a high risk of seeing expenses rise above estimates and revenues fall short of target.

For example, sensitivity to two items is enormous. If VAT revenues do not increase by 13%, as budgeted, and they will very likely not increase due to loss of consumption, then the government’s estimates of tax revenue growth would fall to almost zero.

If transfers to regional governments continue in 2013, something which is quite likely given the regions’ troubled situation, that means another 12 to 16 billion of additional spending.

In terms of budget targets, it appears that the government has fallen into the same trap of previous governments. To provide estimates of GDP growth (-0.5%) that few analysts consider as conservative. The consensus range for 2013 is between -1.2% and -2%. Should the government not have taken the opportunity to build trust giving estimates in line with the consensus of economists and then beat expectations? Beating estimates is essential to regain market confidence.

The goal should be maximum expenditure, not “deficit as a percentage of GDP”

To avoid suspicions on revenue estimates, the state should give a maximum target of spending and put up remedial measures every time such goal was surpassed. If the target is “deficit to GDP”, it masks poor budget execution with ratios that can be manipulated.

Austerity? Where?

What I think is most important to note is that these budgets, as those of 2012, cannot be described as austere. Public spending rises by 5.6%. Yet I hear over and over that the problem is “the cost of debt” … as if the cost of debt was an alien who came down in a UFO surprising the population. As if such cost of debt is not the result of massive public spending.

But even if we deduct the cost of debt, primary expenditure falls only by 0.6%. This is before the regional communities publish their expenses and before any deviation due to bank bailouts or “unexpected” one-offs.

This is not austerity, it is, at best, a slight budgetary restraint
I do not know of any family that comments about their budget “we are doing okay if we remove the cost of the mortgage.” The Spanish budget does not show real cuts, just very slight revisions of previous years’ overspending.

We should highlight it because there is a huge difference between austerity and “less overspend”. Spain will keep spending, including all administrations, almost 20% more than it earns, and will also spend more than it earns without the cost of debt, leading to having to borrow around 200bn a year.

The difference between the “red pencil” and the “Troika axe”

As Art Laffer said, “give me a red pencil and the budget and I will reduce the deficit to zero in a week”. The reduction of debt, not the deficit, is the only solution. And that will come only from cutting spending. Or the Troika will do it for us, but they will do it unfairly and badly.

It is important to repeat that the State and the regions should reduce absolute expenses much more severely, that the state cannot be 56% of the economy, including all public enterprises and that Spain cannot spend 20-25% more than it collects as revenues.

There must be serious cuts in political spending. The presidents of regional governments or ministers cannot have more counsellors-each-than David Cameron.

The Spanish fiscal consolidation process will not be credible unless it structurally reduces the largest expenditure items.

The red pencil. The State can immediately attack four items:

  • Public salaries , a spending of over 100 billion. We have higher public wage expense per GDP than the EU average but a number of civil servants per citizen that is less than the EU average (Eurostat). What is the problem? Too many bosses and too little workers.
  • Consultants and duplicated administrations, which, according to the Association of Businessmen and the PP when it was in opposition, cost more than 22 billion euros. Even if it was half it would be too much.
  • Unproductive investments : In the central government budget of 2012, direct investment in infrastructure- useless high speed trains, ghost “culture and arts” cities and others- amount to 11 billion. According to the latest Stability Program, the gross fixed capital formation, which includes more than infrastructure, was 2.8% of GDP in 2011, and another 1.0 to 1.2% is expected in 2012 and 2013.
  • Subsidies: The amount in 2011 was 11.3 billion and, even in 2012 and 2013, subsidies are expected to exceed 0.8% of GDP. If we add transfers and ministries, we easily reach 15 billion.

Of course, dozens of public television networks, hundreds of public radios… If we attack subsidies and administrative duplication Spain can avoid the “axe” that will come with the bailout, which will look at the expenditure items of over 30 billion and sever them, no matter who is affected and how. Those who call for an immediate bailout request tend to forget what comes with it:

  1. Pensions, a cost of over 100 billion. They may have very significant cuts.
  2. Unemployment benefits, which generate a cost of c30 billion.
  3. Dismissal of civil servants. Not pay cuts, dismissals.

The impact on companies

The Spanish budget impact on companies is not irrelevant. In a very interesting analysis, Ahorro Corporacion shows the companies that are most exposed to Spain (in blue) and exposed to civil works, capital-intensive activities (in gray).

ibex

The impact of the Budget, if we assume that the fall in GDP is only 1%, ranges between 5 and 7% of net profits. Less revenue from income tax, less growth, fewer jobs.

These budgets should have aimed at reducing Spain bond yields. They didn’t.

We know that the country risk will not be reduced if revenue estimates are revised down, spending items are revised up, and debt accumulates with a state structure that survives with short term emergency loans from the ECB without any control of how and when they are granted. Spain runs the risk that the system is not only tax-ridden and confiscatory, but insolvent … and investors, financial or industrial, might think that such risk is too high to invest.

From Bloomberg:

As per the Ministry’s budget statement, Spain plans to borrow €207.2bn next year. Budget Minister Cristobal Montoro said Spain’s debt will widen to 90.5% of GDP in 2013 as the state absorbs the cost of bailing out its banks, the power system, and euro-region partners Greece, Ireland, and Portugal. He added Spain’s budget deficit target of 6.3% will be met because it can exclude the cost of the bank rescue. This year’s budget deficit will be 7.4% of economic output.

Further read:

False austerity in the budget: Here

The situation of Spanish companies worsens: Here

First semester data: Here

Catalonia: bailout and junk bond

Global Economy, On the cover, Sin categoría, Spain

This article was published in El Confidencial on September 1st 2012

“When you blame others, you give up your power to change”
“A sense of entitlement is a cancerous thought process that is void of gratitude and can be deadly to relationships, businesses, and even nations.” Steve Maraboli

On Friday, Standard & Poor’s downgraded the rating of Catalonia to junk after the region made a bailout request to the Spanish central government of €5bn. S&P warned in its report of the “economic and credit deterioration of the region,” and added that “the region’s request to modify key institutional and financial aspects of its relationship with the central government raises uncertainties that we deem incompatible with an investment-grade rating.”

The report also warns that “Catalonia continues to show a poor individual credit profile, with a deteriorating liquidity position dependent on the support of the central government to repay its debt.”

The bailout of Catalonia has generated much controversy in the market, but it’s worth saying that my comments in this article are applicable to most of the regions in Spain.

Despite the huge amount of communication efforts towards investors conducted by the different regions, all with ‘more GDP than Luxembourg and less debt than Japan,’ all considering themselves entitled to borrow indefinitely, the fact is that regions have no access to capital markets. And this shows how, all across Europe, countries and regions continue to believe that credit is free, investor money is unlimited and deserved without questions. And there is no unlimited capital.

The excellent presentation to investors that the Catalan government, theGeneralitat, made in 2011, very complete and detailed, shows some of the common problems that Spain and the regions face, and the reason why investor confidence and interest are still low.

. Estimates that were very optimistic: “Our revenues cannot fall.” “In 2012, with very conservative estimates, revenues will increase by 10.5 percent.”

. A debt maturity schedule that implies annual needs of €3bn added to the current financing needs of nearly €9bn. Added to that, the habit of financing current expenditures with long term debt and weakening future revenues, as Catalonia has received advances on transfers of more than €10bn until June 2012 – advances spent today that will not be collected later.

. The average maturity of the Catalan debt is six years. More than 71 percent of its debt matures between two and five years. I always tell my readers of the importance of not accumulating short-term maturities in good times as risks accelerate exponentially in times of recession. Accumulation of maturities well above marginal institutional demand is a problem throughout the European periphery coming from the misperception that “there is plenty of available demand” in the credit market for all, when the United States and major countries account for nearly all of the debt market capacity.

. Expectations of international funding sources were not met and have only been partially covered by local retail investors.

. A primary deficit – the gap between income and expenses excluding cost of debt – which has done nothing but grow.
. The estimates that Catalonia provides of fiscal deficit – the difference between tax revenues received from Spain and paid out – which, even if we assume it to be valid, does not cover the hole of growing expenses. The problem is, therefore, the accumulation of previous debt and expenses and that, in any case, investors perceive the fiscal deficit figure as exaggerated, because it assumes no cost for Catalonia of EU transfers or value-added taxes to other regions. In addition, from 2007 to 2011, state tax collection in Catalonia plunged by 35 percent, while subsidies and allowances paid by the central government to Catalonia increased.. The estimates given of the Catalan economy forget the CatalunyaCaixa andUnnim bailouts (€2.3bn), which are not accounted as a cost incurred by the region.

The real problem, however – the reason why investors do not rush to buy Catalan bonds that give a return of nearly 12 percent in 2016 – is that it has been proven since 2004 that any increase in revenues is engulfed by the regional administration and as such, the risk of default is higher than implied by companies and the region’s financier, the Spanish central government or Germany.

I heard this a few times from colleague credit investors: “a country that doubles its expenses in four years while its revenues fall, either has oil, or gold, or it does not have my money.”

The 10-year-Catalonia bond has a risk premium –spread– to Spain of almost 600 basis points and 1,100 basis points over Germany. This difference is not because of Catalonia’s dependency on Spain, or the alleged fiscal deficit. It is caused by the massive deterioration of expenditure and revenues, and the accumulation of debt maturities far beyond institutional demand. And it is important to say this, Catalonia is one of the regions with better credit structure. So, imagine the rest.

In fact, if investors perceived the massive spread between Spain and Catalan bonds as unjustified by the fundamentals, they would take the arbitrage opportunity and load up in Catalan bonds. Any credit arb hedge fund would buy them in size. But they don’t.

Now the blame game heats up. Spain blames Germany, Catalonia blames Madrid, Andalusia blames the banks, etc. Meanwhile, with on-going downward revisions of the gross domestic product and failures in budget implementation, governments continue to believe in the mantra of eternal credit ‘because we deserve it,’ sinking the ship with the crew and passengers inside.

In the Spanish regions and the central government, each euro received of additional income, either through taxes or transfers and structural funds since 2004, has become inexorably a euro and ten cents of debt. Looking at the Spanish regions, all the money received has been spent, but all of them have expanded primary deficit as well. In 1993, the regions managed 20.1 percent of the country’s budget, today they manage nearly 60 percent, yet all of them spend far beyond their means and income, regardless of their business and economic differences. Here in Spain there is no poor state. No Alabama. We are the United States where everyone is Washington or California.

This leads us to a comment made ​​by my esteemed Xavier Sala i Martin, Spanish-American economist at Columbia University, who says that the problem of access to debt markets for companies is mainly because they are Spanish, and that if Catalonia were an independent country “it would be considered one of the world’s healthiest economies and financial markets would rush to lend it money.”

In this post, I am joined by my fixed income colleague to give readers an idea of ​​how the debt markets work, because it is false that the main indicators to buy bonds are just debt to GDP and deficit, and I remember the comments from one of the British investors when the premier of the Generalitat made the presentation of its bonds in London. “If Catalonia was an independent country it would have the same access to credit as Andorra,” he said.

But even more surprising to me, as an investor in equities and bonds, is to read that “financial markets would rush to lend money” to an independent Catalonia. That is not true, as we have seen from country after country that declared themselves independent, from Yugoslavia to the former Soviet Union. Either they have abundant energy commodities or credit evaporates until they have gained years of experience as independent states. Estonia, the example for independence movements, only saw some modest short-term credit because Germany broke the treaty rules and recognized the country quickly. Even with that, credit was modest and GDP collapsed by 14 percent in 2009 and 9 percent in 2010.

When investing in bonds – debt to GDP, which is an indicator, inflated precisely by government spending and real estate bubbles – is irrelevant. What matters is the institutional credibility, the acceleration of expenditure against income, the quality and predictability of that income, the weight of public spending, monetary stability and the primary deficit or surplus.

We assume that Catalonia has institutional credibility, but:

. An independent Catalonia would be an economy that depends by 57 percent on Spain for its “exports.” In fact, since the trade balance with “non-Spanish” countries is negative (Catalonia imports more than it exports), Catalonia’s exposure to “Spain” would remain the same if not higher, particularly on the risk of the bonds of the alleged independent Catalonia. The cost of belonging to the EU, however, which Catalonia does not pay today as a region, would expand its deficit. Add to this that an independent Catalonia would have to absorb 18 percent of Spain’s national debt on the way out, and Catalonia would have debt to GDP higher than 100 percent. In a Spanish recession, the independent Catalonia bonds would also aggressively discount that same recession.

That’s why, despite the huge attractions and exceptional positive elements of Catalonia – dynamic, open economy – the investors perceive as the biggest problem the structure of a state that swallows any extra income received as it has done since 1996, making the solvency and liquidity ratios very tight, and this will continue to impact their access to credit. In fact, it is precisely the liquidity ratio, even assuming the previously mentioned tax deficits, which scares investors. Because the deterioration of income – with the deindustrialization of the region into more competitive and less bureaucratic countries, like Morocco – is accompanied by expenditures which can only rise, and do not take into account that the economy of Catalonia is very cyclical.

We end with a note on the “negative impact of being Spanish” to finance large companies. Sala i Martin says that ”the reason (for not having access to credit) has nothing to do with the sector in which they operate or the state of their economic health. The reason is simply that they are Spanish companies.”

First, we have seen debt issues, divestitures and hybrid access by several of these companies (Gas Natural, BBVA, Telefonica and other Spanish companies have issued €7.05bn in bonds with over 10 times demand in 2012), and all are trading at less risk of default than Spain or Catalonia. What we have said in this column many times is the real problem. The average debt of the Ibex is very high relative to its peers due to the orgy of strategic acquisitions at crazy multiples, but we have seen companies do an exercise that neither regions nor the central government have done. Prudence. Aggressively reducing costs, cutting unnecessary investments, cutting dividends, funding themselves long term since 2007 to avoid the “credit crunch.” That is, the opposite of what the governments have done. Companies have been preserving cash generation as an essential policy against an uncertain future, both in its core business as in its “growth markets.”

Surprisingly, Sala i Martin takes as an example of the ‘bad influence of the Spanish state’ three companies with almost monopolistic businesses in national services, telephone, natural gas, and construction-concessions. Great companies which have financed their international expansion with a lot of debt that they have been able to accumulate thanks to very high returns generated in Spain, which allowed them to enjoy better growth than their peers in the past, with full access to borrowing that could not have been there without the support of those domestic revenues and without a Spanish government that supported high risk cost strategic adventures.

No company is Spanish only for the good times and not for the bad times. These large companies, which enjoy a very comfortable monopolistic position in our country, do not suffer lack of credit “for being Spanish.” This is like saying that France Telecom, Veolia, EDP, Telecom Italia or Areva suffer lack of access to credit for being French, Portuguese or Italian rather than their strategic mistakes of expansion with debt.

Catalonia is wonderful and deserves all the good things that can happen there and more, and it is worth a bailout, or twenty, if needed. Spain has regions-nations – whatever you want to call them – with wonderful, huge possibilities. The problem was, and remains, having an unsustainable structure of administrations that absorb any extra income they get. Everyone has the right to claim independence for romantic reasons, or whatever, but we cannot say that the markets would be jumping to provide credit. In five years we would see Barcelona wanting to cut ties with Lleida or Madrid with Guadalajara, until the final implosion of a country with a level of public spending crowding out the real economy that looks like Argentina.

In Spain today, there is a golden opportunity to change, and to unite the country in the solution, not separate ourselves in the debacle. But let’s not blame the other. The solution is in our hands.

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Here is Mr Sala i Martin’s original article and his reply to my post above

On fiscal deficits. here is the contrarian view to Catalonia’s government one.