Having provided ample arithmetical evidence of the inevitability of a default of restructuring of the debt of
- Ireland (Here’s Something That You Will Not Find Elsewhere – Proof That Ireland Will Have To Default…),
- Portugal (The Truth Behind Portugal’s Inevitable Default – Arithmetic Evidence Available Only Through BoomBustBlog),
- and Greece (What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates),
it is now time to turn to Spain. Spain is unique among the aforementioned group in that the amount of capital necessary to bail out this country is likely beyond the ken of the EU/IMF, and will likely assure a contagion effect. While it is true that Spain is not as indebted as the smaller periphery countries from a proportionate perspective, it is likely that it is not on a sustainable path and the efforts to make said path sustainable will may require restructuring/default, particularly if the smaller periphery states default. Of course, Spain doesn’t necessarily see it his way, at least according to the mainstream media. From CNBC:
Spain will not be next in line for a rescue package from Europe but a common economic policy is needed to support a single currency, Spanish Economy Minister Elena Salgado told BBC Radio on Friday.
This is a current snapshot of Spain as it stands now (excerpted from our subscription report Spain public finances projections_033010 and the online restructuring model - The Spain Sovereign Debt Haircut Analysis for Professional Subscribers):
As it stands now, the government expects to increase its debt from 55.2% of GDP in 2009 to 74.3% in 2012. In absolute terms, the government debt is expected to grow from €580.4 billion in 2009 to €848.3 billion in 2012. However, we expect the debt to increase much more owing to a shortfall in government’s targeted fiscal consolidation, primarily on account of lower-than expected economic recovery. Spain is expected to reach a debt/GDP ratio of over 100%, and that is using its highly optimistic numbers – numbers that have, to date through the most recent crisis, failed to come anywhere near anything that could even be considered a simulacrum of reality. See Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! or let use excerpt the subscription-only report, Spain public finances projections_033010:
So, even taking a considerable amount of Spain’s unbridled optimism for granted (some adjustments had to be made in order to get anywhere near a realistic scenario analysis), projecting Spain’s finances out into the future STILL shows significant shortfalls and a debt to GDP ratio that STILL breaks the 100% barrier. Just imagine if the truth be told!
Remember, according to the Maastricht Treaty (the agreement that allowed sovereign nations admittance into the Euro), “The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.” Not only is Spain nowhere near that number as of next year, even according to its own numbers, but they are rapidly shooting much farther away, whether one uses reality or their highly optimistic and unlikely projections.Wikipedia on the sustainable debt to GDP ratios:
In economics, the debt-to-GDP ratio is one of the indicators of the health of an economy. It is the amount of federal debt of a country as a percentage of its Gross Domestic Product (NYSEMKT:GDP). A low debt-to-GDP ratio indicates an economy that produces a large number of goods and services and probably profits that are high enough to pay back debts. Governments aim for low debt-to-GDP ratios and can stand-up to the risks involved by increasing debt as their economies have a higher gdp and profit margin. The level of public debt as % of GDP around 2008 in Japan and Germany was around 60%,[which was also close to the EU's criteria for member states to participate in the Euro]. As of 2010, the United States holds a debt-to-GDP ratio of around 94% [readers should be aware that the US has control of its own currency, though].
…The debt-to-GDP ratio is generally expressed as a percentage, but properly, has units of years, as below.
By dimensional analysis these quantities are the ratio of a stock (with dimensions of Currency) by a flow (with dimensions of Currency/Time), so[note 1] they have dimensions of Time. With currency units of US Dollars (or any other currency) and time units of years (GDP per annum), this yields the ratio as having units of years, which can be interpreted as “the number of years to pay off debt, if all of GDP is devoted to debt repayment”.
This interpretation must be tempered by the understanding that GDP cannot be all devoted to debt repayment – some must be spent on survival, at the minimum, and in general only 5–10% will be devoted to debt repayment, even during episodes such as the Great Depression, which have been interpreted as debt-deflation – and thus actual “years to repay” is debt-to-GDP divided by “fraction of GDP devoted to repayment”, which will generally be 10 times as long or more than simple debt-to-GDP.
Consider much of the EU to be in a deflationary state as we speak…
Spain’s Government Officials Have Apparently (a polite way of saying unkonwingly) Declared That The Country Is On The Path To Crisis
There is no hard an set formulaic equation or template to indicate whether a country is going to default or not from a historical perspective, save one. Each and every recent historical default was the result of a very rapid increase in public debt to GDP, often after a banking or credit crisis and deterioration in both public finances and access to private debt markets. This has Spain’s (or any nation in the area, it is literally a game of pick a PIIGS) name written all over it. Here is the historical and projected Debt/GDP numbers using the Spanish Government’s projections (not our scrubbed for reality calculations):
Higher debt paired with reduced market access typically generated debt servicing difficulties, ultimately culminating in either default or the urgent need for a preemptive restructuring to avoid a default.
As quoted directly from the IMF, “… over the past 30 years, 60 percent of sovereign debt crises occurred when debt levels in the year preceding the crisis had been higher than 39 percent of GDP. Moreover, a 50 percent probability of being in a debt crisis is associated with a debt-to-GDP ratio of 80 percent.”
So, where does Spain stand??? The Spanish government says it expects debt/GDP to be 74% by 2012, with a fiscal deficit of 5.3%. We say rubbish, and have calculated both a debt/GDP and fiscal deficit level materially higher than Spain’s government alleges, and above that 80% line of demarcation mentioned above. Look at their track record illustrated above in the excerpts from Spain public finances projections_033010 and compare it to ours and it is easy to see who’s word holds more water.
Basically, the best way out is a restructuring. We have applied an “Argentina Restructuring Scenario” to the Spanish debt below, and compared it to the current state of affairs. As you can see, bondholders will take a nominal hit via haircut, and as well as a more substantial hit via the decrease in NPV of expected cashflows. Of course, this is better than certain alternatives…
This is what the Argentinian bonds looked like when they were restructured…
Price of the bond that went under restructuring and was exchanged for the Par bond in 2005
Price of the bond that went under restructuring and was exchanged for the Discount bond
I don’t believe the Argentina scenario is the most fitting here, since Spain can create more of a win-win scenario, although pain will be felt by the debt holders regardless. Below is a description of the various scenarios calculated and made available to all professional and institutional subscribers. See The Spain Sovereign Debt Haricut Analysis for Professional/Institutional Subscribers. Click here to subscribe.
Even if Spain were to receive assistance in the form of a bailout from the IMF/EU, the problem is simply kicked down the road, and not rectified. Again, the year 2013 is the magic number and the day of reckoning.
Next up, we will explore the contagion effects abound in Europe. Subscribers please review:
- Sovereign Contagion Model – Retail (961.43 kB 2010-05-04 12:32:46)
- Sovereign Contagion Model – Pro & Institutional
See The Spain Sovereign Debt Haricut Analysis for Professional/Institutional Subscribers for the complete Spain restructuring spreadsheet online. All others can click here to subscribe or upgrade. Those of you who are curious to see what the complete restructuring scenario looks like, I have made the Portugal restructuring analysis available free of charge for the time being: The Anatomy of a Portugal Default: A Graphical Step by Step Guide to the Beginning of the Largest String of Sovereign Defaults in Recent History
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.