It is a rule of thumb among eurozone crisis observers that the more something is denied by officials, the more likely it is to happen. With Spain’s borrowing costs at euro-area record highs, its officials insist it will not need a full bailout programme. To most of us, however, it seems no longer a question of if, but when a bailout will come. Market panic this week seems to suggest it is imminent, but I think it will be put off as long as possible, probably until early next year.
Long-term borrowing costs may have broken an eye-watering 7.5%, but the fact that short-term borrowing costs have rocketed as well is more worrisome. This indicates a lack of investor confidence that Spain will be solvent even over the next two years.
Greece, Ireland and Portugal were all pushed into bailout programmes shortly after their long-term borrowing costs exceeded 7%. But there is no magic number above which borrowing becomes unsustainable. In theory a country could survive if it made a bigger fiscal adjustment so that it had more money to pay down its debt.
Spain is not in the same position as the other bailed-out countries because it is nowhere close to running out of cash. It has a long average debt maturity, so its debt will not be raised at such high rates all at once. But its difficulties are significant and varied: a seeming black hole of a banking sector, huge regional debts, soaring unemployment and accelerating capital flight. A sovereign bailout wouldn’t necessarily address any of these issues. But it probably wouldn’t hurt either. Loans from the EU bailout funds – the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) – would be offered at much lower borrowing costs than Spain is currently able to get in the markets.
The biggest downsides of any bailout are the strict conditions attached to it, but Spain is already subject to many of these – including the excessive deficit procedure, which requires it to commit to deficit and debt targets over the next few years. What conditionality isn’t already demanded by the European Commission has been imposed by the markets. With each surge in bond yields over the past year, Spain has announced waves of austerity measures and structural reforms of the kind that would normally be demanded in a bailout.
Still, the Spanish government is going out of its way to avoid it. In part this is because of concerns that it will be unable to regain market access once it loses it by borrowing from the EU bailout funds. But a delay is also important to the rest of the eurozone. Though Spain may be hogging the limelight now, Italian borrowing costs are only slightly lower. Were Spain to be taken out of the markets, investors would focus on Italy, which would soon also need a bailout. It is an open question whether the EU funds and IMF have enough between them in theory to cover Spain and Italy’s needs over the next few years.
What we do know, however, is that there is not in practice enough bailout money for those two countries now. The ESM has not been ratified yet and will not be implemented until September at the earliest, when the German constitutional court makes a final ruling on its legality. Furthermore, bailout money from the IMF has been pledged by individual G20 countries but is not yet in place. That leaves only about €200bn in unearmarked funds in the EFSF.
The EFSF alone has no chance of covering Spain and Italy’s borrowing costs over the next few years. An immediate pledge to bail out Spain and then Italy in the absence of ESM and IMF money would lack credibility. Together, these funds are meant to be a firewall. If Spain requested a bailout now, eurozone policymakers would be left trying to protect two big countries with what amounts to a fence made of toothpicks.
Megan Greene is director of European economics at Roubini Global Economics.