With 10Y yields trading below those of US Treasuries, asking the question of Spain's rising default risk seems risible but as Bloomberg's Maxime Sbaihi notes, the longer the euro flirts with deflation, the higher the risk that the heavily indebted (and becoming more so) countries will be tempted to default. Of course, this 'concern' is entirely ignored by the 'market' as Draghi has promised enough liquidity to soak up every short-dated bond but as the European Union's so-called "1/20 rule" suggests - requiring states to reduce excessive (over 60% Debt/GDP) by 1/20th every year or face a fine of 0.2% of GDP - Spain, it appears has 5 options to escape this vicious circle... and one of those is restructuring...
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To reduce its public debt, Spain can choose among five options, which are not mutually exclusive.
- The first is to attempt to grow GDP faster than public debt in order to reduce the ratio. According to International Monetary Fund forecasts, annual GDP growth in Spain will remain below 1.3 percent until 2020. This is not enough to stabilize the debt ratio, according to Bloomberg Brief calculations.
- The second option is to pursue fiscal adjustment until the primary balance — the budget balance without debt interest payments — reaches a surplus. With a primary deficit of 4 percent, Spain still needs further consolidation, heightening political risk from voters who show increasing signs of austerity fatigue. Reducing the deficit too quickly might also endanger the recovery.
- Another option is financial repression, involving state-dictated measures such as interest-rate caps, direct lending to the government or regulation of capital flows. This runs up against reputation risk, political backlash and legal issues, especially in a currency union. Yet it remains a possibility after some features were implemented during the banking sector bailout in Cyprus.
- Another even more radical option is to restructure or fully default on the debt. That has become more conceivable with the Greek precedent and years of austerity fatigue. In a December 2013 paper on debt restructuring, Carmen Reinhart and Ken Rogoff warned: “restructurings will be needed, particularly, for example, in the periphery of Europe, far beyond anything discussed in public to this point.”
- One final option is to rely on inflation. Spain’s public debt is fixed in nominal terms, except for one 5 billion euro inflation-linked bond issuance last month. Higher inflation means a lower real value for repayments. Given the current debt stock, even 3 percent inflation in Spain would only reduce public debt to GDP by 1 percentage point by 2025, according to Bloomberg Brief calculations based on IMF projections
Repression has been tried and the banks are already neck deep in it... growth is a joke in the new normal... fiscal adjustment is simply (as we have seen) too much pain for politicians... and inflation is going the wrong way... leaving one option (as unpalatable as it is)... default/restructure.
Source: Bloomberg Briefs @MxSba
