Spain's economy should avoid Portuguese domino effect

25th March 2011, Comments 0 comments

Spain and Portugal are close economic partners and investors have doubts about the solvency of both countries as they try to stabilise their strained public finances.

But analysts says Madrid should escape any domino effect if its neighbour is forced to seek a financial bailout -- thanks to the robust economic reforms it has carried out since last year.

Portuguese prime minister Jose Socrates resigned Wednesday after the opposition rejected his plan for more spending cuts and tax hikes.

Late Thursday, Standard and Poor's lowered its rating for Portugal's long-term public debt two notches to "BBB" from "A-", heightening fears it will need an international rescue.

It also revived concerns that Spain may be next on the list.

"A few months ago, it is true that everyone was in the same bag," Greece, Ireland, Portugal and Spain, said French bank Natixis' southern Europe analyst Jesus Castillo.

"Since then we have seen Spain make major reforms on pensions and the labour market, and the thing that has been really crucial in differentiating it from Portugal and other southern European countries is the reform of the financial system," he said.

In less than two years the country has forced the weakest savings banks to merge, reducing their number from 45 to just 14, while imposing strict new rules to bolster balance sheets.

Previously "we were in the same boat and the impression was that after Portugal it was Spain's turn," said Marian Fernandez, a strategist at Spanish bank Inversis.

But now the impact of any bailout plan in Portugal "should be minor because the market for several months has valued the fact that the situation in Spain is different from that of Portugal."

Asked about the risks of the crisis spreading from Portugal, Finance Minister Elena Salgado said: "The markets have shown that they recognise the efforts" made by Spain.

"We should continue to grow. I think we are doing what is necessary on this and we will continue to do the same."

Spanish bonds barely reacted to the Portuguese crisis.

The Spanish 10-year bond risk premium -- the extra return demanded by investors when compared to safer-bet German bonds -- fell to 1.92 percentage points Thursday from 1.99 percentage points a week earlier and 2.83 percentage points at the height of Spain's woes in November last year.

"Peripheral tensions still seem largely confined to Portugal, Ireland and Greece with Spain still not on investors' radar screens," said Citi in a research note.

But some experts warned that the respite may be short-lived for Madrid.

On the one hand, "the exposure of Spanish banks to Portugal is very high, around 80 billion euros ($113 billion)," said Javier Diaz-Gimenez, a professor at Spain's IESE Business School.

He said Portugal is "one of the big risk factors" for the Spanish economy.

A rescue plan for Portugal "could step up speculative pressure on the Spanish bond market," forcing the Treasury to pay higher interest rates when raising fresh funds, said an analyst with Rabobank.

"Every time funding costs lurch higher, the likelihood of a bail-out increases."

Diaz-Gimenez noted that Spain also "has its own problems in addition to Portugal."

These include an unemployment rate of more than 20 percent, negligible economic growth, regional budgets largely beyond Madrid's control and a banking sector whose capital needs will surpass tens of billions of euros in the coming months.

"This remains a country in difficulty because its long-term solvency is not 100 percent guaranteed," Jesus Castillo of Natixis said.

Said Marian Fernandez: "The European periphery remains in the line of fire and even if we emerge from the group of countries which are worst affected or those on course for a bailout ... the markets will continue to keep (us) under surveillance."

© 2011 AFP

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