While Spain?s overall banking problems are nowhere near as severe as Ireland?s, the small, struggling regional banks known as cajas threaten Spain?s recovery.Denis Doyle/Bloomberg
As the Irish banking crisis turned critical and Portugal moved ever closer to an international bailout, Spanish Prime Minister Jose Luis Rodriguez Zapatero took desperate measures to prove his country is not the next debt disaster.
The Spanish government in 2009 and 2010 rolled out one of the toughest austerity programs on the continent, forcing civil servants to take major pay reductions, and introducing structural reforms to improve its competitiveness, such as slashing employee severance packages.
Despite the deep cuts, Spain's efforts have long appeared hopeless. Spain's property collapse was Europe's worst. Its regional savings banks, known as cajas, were swamped with dud real estate loans. The unemployment rate surpassed 20 per cent. The budget deficit was out of control and bond yields hit dangerous levels as investors feared that Spain would join Greece and Ireland in the euro zone's palliative-care ward.
Those fears seemed to heighten in recent days, when Portugal's debt was downgraded to one notch above junk status and a backlash against austerity measures triggered the collapse of the Lisbon government. The fifth bailout of Ireland's banks, announced Thursday, attracted more attention to Spain's own banking problems.
But any investor betting on Spain's collapse might be disappointed. While the crisis headlines focus on Portugal, Ireland and Greece, Spain has been quietly scoring a few fiscal and economic victories. Spanish bond yields have stabilized in recent months, and even retreated in recent weeks, while Portugal's went in the opposite direction.
Some economists are now taking the view that the worst is over for Spain and that it should no longer be viewed as an Ireland or Portugal in the making. In a note published March 31, a team of Deutsche Bank economists and strategists led by Gilles Moec noted Spain's economic "resilience" since mid-2010 and predicted that "this country should be able to deliver a positive, albeit slow, growth rate consistent with a sustainable path for public debt."
There are caveats, of course, the biggest being the successful recapitalization of the cajas. While Spain's overall banking problems are nowhere near as severe as Ireland's - Santander and other big Spanish banks are among the healthiest in Europe - the small, struggling cajas threaten Spain's recovery.
Madrid's effort to restore confidence in the banking system suffered a blow this week when the planned merger of four cajas collapsed over fears that one of them, Caja de Ahorros del Mediterraneo (CAM), had assets of dubious quality. On Friday, the Spanish media reported that Banesto, a subsidiary of Santander, was the lead contender to buy CAM.
During the boom years of the past decade, Spain generated more jobs than any other euro zone country, thanks to cheap credit and a construction boom that quickly went from enthusiastic to preposterous. Residential investment funded by property developers reached a peak of 7.5 per cent of Spain's gross domestic product in 2006, compared with 5.5 per cent in Germany, while construction employment reached 13.3 per cent of total employment (5.6 per cent in Germany).
When the financial collapse came in 2008, the housing market died overnight. Entire suburbs turned into unfinished wastelands and the unemployment rate, which had been 8.3 per cent in 2007, more than doubled to 20 per cent.
Spain's gross domestic product fell 3.7 per cent in 2009 and dipped slightly in 2010. When the euro zone's sovereign debt crisis went into full swing last year, with the bailouts of Greece and Ireland, the conventional wisdom was that Spain would, at best, have to endure a double-dip recession; at worst, it would get infected by debt contagion and require a bailout.
It appears the chances of either happening are receding by the day as the government's tough new austerity measures take hold. Tourism is returning to normal levels and the nation is benefiting from higher exports to recovering euro zone countries.
Deutsche Bank said the "positive surprise" in 2010 came from resilient consumer spending, thanks to the stabilization of the job market - the construction sector stopped shedding jobs. Overall exports picked up by 17 per cent, while those going to Latin America rose twice that fast. Meanwhile, the labour market has become somewhat more flexible with the introduction of measures such as smaller severance packages for unwanted employees.
On the fiscal side, Madrid took an axe to spending, reducing public sector wages by 5 per cent and eliminating thousands of government jobs. A hike in the value-added tax lifted revenues. As a result, the central government's deficit (excluding the regional governments') came down quickly, from 9.3 per cent of GDP in 2010 to 5 per cent last year, ahead of target.
In late March, when it looked like Portugal would fall off a cliff, Spanish Finance Minister Elena Salgado did not seem perturbed. "We have to keep doing what we have been doing so far - continue to enact reforms, live up to our commitments, strengthen our economy."
What about the cajas? Deutsche Bank thinks their restructuring has to pick up momentum. The cajas, it said, may have to raise another €29.2-billion ($40-billion) from the government and private investors. It is not ruling out a "shock and awe" recapitalization effort, valued at €70-billion, if investors consider the lesser amount inadequate to shore them up. Once the cajas are put right, they can start extending credit again to businesses such as exporters.
Spain may not be fixed, but appears to be in far better shape than the peripheral EU countries. "In the short term, we will struggle," said Jose Manuel Amor Alameda, partner and strategist with AFI, a Madrid financial and economics consultancy. "Anyway, this is a marathon and I think we'll be fine."