Spain’s Debt Pile Won’t Go Away With Direct Bank Rescue

Something isn’t working when, 10 days after Spain became the fourth euro member to get aid to stem a spike in borrowing costs, those borrowing costs reach a record high.

Graphic by Tom Hall/Bloomberg

Spanish government borrowing costs since the beginning of the year

Prime Minister Mariano Rajoy, talking at the G-20 meeting in Mexico yesterday, said Europe must break the link between banking and sovereign debt. He wants the 100 billion euros of European rescue funds to go directly to the Spanish banks that are in trouble rather than being given to the government to hand out. If the government is given the money first it’s then on the hook to repay it should the banks fail. In accounting terms, the rescue money adds to the government’s debt rather than relieving it. That’s why Spain’s borrowing costs have become unsustainable.

Now, assuming German Chancellor Angela Merkel were to accept that, and funds were handed over to companies overseen only by the Spanish central bank, it’s still unclear whether Spain would get by without a government bailout.

The government’s debt in the first quarter had risen to 774 billion euros, or 72 percent of GDP, from 684 billion euros, or almost 65 percent of GDP, a year earlier, as this graphic from El Pais shows. The regional governments owed 145 billion euros, or 13.5 percent of GDP, compared with 125 billion euros, or 12 percent of GDP, a year earlier. The only segment of the Spanish administration that lowered its debt level in those 12 months was local councils, which owed 36.8 billion euros at the end of March, down from 37.3 billion euros in the first quarter of 2011.

Even if Merkel backs down and Rajoy gets his way, with Spanish banks being rescued directly by Europe, the government will have to show very soon and very clearly that government debt is going to be reduced.

This was the result of Spain’s bill sale yesterday, as Emma Charlton and Lucy Meakin report:

Spain sold 2.4 billion euros of 12-month bills at an average rate of 5.074 percent, 2.1 percentage points more than the yield paid at a May 14 sale, the Madrid-based Bank of Spain said. It also auctioned 639.3 million euros of 18-month debt at 5.107 percent, compared with 3.302 percent last month.
Ten-year Spanish rates declined 12 basis points to 7.04 percent, while yields on similar-maturity Italian debt slipped 17 basis points to 5.91 percent.
Spain plans to sell 2 billion euros of notes due in 2014, 2015 and 2017 in two days.

The good news was that Spain managed to borrow all the money it had intended. However, the rates it’s paying, as West LB fixed-income strategist John Davies says, are not sustainable.

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