Analysis: Spain, Portugal debt vulnerable to slow growth

By Brian Love, European Economics Correspondent

PARIS (BestGrowthStock) – New austerity plans set by Spain and Portugal will produce only small improvements in their debt trajectories, and weaker growth due to the austerity could erode even those modest gains, Reuters calculations suggest.

The two countries, faced with the risk of a Greek-style debt crisis in which they could lose their ability to fund themselves in the market, announced fresh austerity measures in mid-May, front-loading steps which they had originally hoped to spread more gradually over the four years through 2013.

The existence of the new plans, combined with unprecedented purchases of the two countries’ bonds by the European Central Bank, has partially eased market jitters and helped the countries keep access to the market.

But simple spreadsheet models of their economies and debt structures, prepared by Reuters, show the new plans are very vulnerable to slow economic growth.


Spain’s extra measures, worth 15 billion euros, would reduce the rise in the ratio of its public debt to gross domestic product by roughly two percentage points in 2011 and each of the two subsequent years versus the government’s original targets.

That would leave it with a public debt ratio of 72.1 percent in 2013 instead of the 74.1 percent initially expected.

But the growth assumptions in that plan are already looking too optimistic; at the end of May, the government lowered its forecasts for real GDP expansion to 1.3 percent in 2011 instead of 1.8 percent, 2.5 percent in 2012 rather than 2.9 percent, and 2.7 percent in 2013 instead of 3.1 percent.

Plugging those GDP figures into the calculator for Spain reduces the improvement in the debt trajectory due to the new austerity measures by roughly one quarter; instead of beginning to fall in 2013, the debt/GDP ratio stays flat at 72.7 percent that year.

The simple spreadsheet model probably understates the extent to which tax revenues could be hit by slower economic growth.

And many analysts think the government may be forced to cut its growth forecasts once again. Spanish consumer sentiment fell at its fastest rate on record in May, partly because of concern over government policies, according to Spain’s National Credit Institute.

“A fall in consumer spending could drag Spain back into recession by the end of the year,” said Raj Badiani, economist at IHS Global Insight, a consultancy.

The model also shows how vulnerable Spain is to increases in debt servicing costs as nervous markets demand higher yields.

After hitting a peak of 4.50 percent in early May, its 10-year government bond yield fell back to 3.95 percent in response to the ECB’s bond-buying and Madrid’s new austerity drive — but since then, the yield has rebounded even higher, to 4.60 percent.

Adding just 0.5 percentage point to Spain’s assumptions for its affective debt service interest rate in 2010-2013 brings its debt/GDP ratio at the end of that period to 73.7 percent, barely different from the 74.1 percent envisaged before the latest austerity measures.

The model does not, however, capture the potential political instability created by austerity measures. Spain’s new austerity steps passed by just one vote in parliament, raising the possibility of early elections. Opinion polls have given the opposition center-right Popular Party a lead of 9-10.5 percentage points over Socialist Prime Minister Jose Luis Rodrigues Zapatero’s government.


Portugal announced in mid-May that it would pursue extra spending cuts and tax rises to secure additional deficit reduction of one percentage point in 2010 and two percentage points in 2011.

Such cuts appear to produce a debt/GDP ratio of 86.7 percent in 2013, compared to the 89.8 percent which Portugal previously envisaged for that year.

Political risks look smaller in Portugal; Socialist Prime Minister Jose Socrates has secured opposition party promises of support for the extra cutbacks and the overall outline of the plan, which starts with two billion euros of cutbacks this year, has won approval in parliament.

But Portugal’s growth prospects may not be nearly as good as its assumptions. The European Commission said earlier this year that it believed Lisbon might be overly optimistic, and Standard & Poor’s said the growth outlook was the main reason that it lowered Portugal’s credit rating in late April.

S&P predicted stagnation for the Portuguese economy this year and next, predicting GDP growth would return to 1 percent only in 2012. It also said inflation would likely average 0.6 percent in 2010-2013, well below the government’s forecasts.

Plugging S&P’s growth and inflation assumptions into the Portuguese model, the hoped-for fall in the debt/GDP ratio during 2013 evaporates. Instead, the ratio keeps rising through that year, to 91.1 percent.

Applying domestic inflation rates to Portugal’s debt stock is inexact because the debt is in euros, which are subject to the overall euro zone inflation rate. But the model does show the dangers of deflation or ultra-low inflation as countries try to work themselves out from under their debt mountains.

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(Editing by Andrew Torchia)

Analysis: Spain, Portugal debt vulnerable to slow growth