Stimulus Will Do Little for Spain's Worsening Debt

Carlos Sanchez Pereyra | Getty Images

Spanish Prime Minister Mariano Rajoy is expected to announce stimulus measures as soon as Friday and the EU looks willing to ease budget deficit targets for Madrid, but it could all be in vain as the debt mounts up, according to an HSBC economist.

Madhur Jha, a global economist at HSBC, warned on Thursday that Spain will see weaker growth this year, deficit targets will have to be eased and falling bond yields won't guarantee debt sustainability.

"We believe that unless the consolidation targets are eased, the Spanish economy will face a deeper recession in 2013 and higher unemployment, potentially leading to growing social unrest and rising regional separatist calls," Jha noted.

The European Commission signaled that it could ease Spain's budget goals this week, but Jha noted: "Even if Spain's debt targets are eased giving Spain more time to reach its consolidation goal, the debt dynamics continue to worsen for Spain over the medium term."

Data released on Thursday showed that Spain's economy contracted 1.8 percent in the fourth quarter from a year earlier, adding to a gloomy economic picture of record unemployment of 26 percent and 30 months of declining retail sales.

(Read More: Investors Throw Spain a Lifeline as Economy Shrinks)

With his poll ratings already at an all-time low, after introducing unpopular austerity measures, Prime Minister Mariano Rajoy has proposed a package of stimulus measures to boost the ailing economy.

The measures could easily be overshadowed by a growing corruption scandal hitting the Spanish press, in which Rajoy and members of his ruling Popular Party (PP) are accused of taking secret cash payments from business donors.

Spain's Debt Dynamics

"While European Central Bank (ECB) support and a few innovative government measures could keep the pressure off Spanish bond markets in 2013, the debt stock continues to rise. For debt to stabilize, growth will have to pick up sharply – unlikely in the face of more austerity, continued deleveraging in the financial sector and a staggeringly high unemployment rate," Jha noted.

Spain's bond market has belied the economic fundamentals, with borrowing rates seemingly stable since the ECB announced a program of Outright Monetary Transactions (OMT) in which it could buy unlimited sovereign bonds, albeit with strict conditions attached.

Jha noted that falling bond yields were certainly helpful in improving debt sustainability but that the debt burden – of 90.5 percent of GDP by the end of 2013, according to Spanish treasury – would not decline.

"Even if the ECB decides to undertake unlimited bond purchases, bond yields would have to fall to impossibly low levels really to dent the growing debt burden. Growth then remains essential for debt sustainability, but we are unlikely to see it this year."

Too Little, Too Late?

HSBC's Jha recognized that 2012 had been a "year of significant change for Spain" with a new government committed to austerity, a banking sector bailout, regional liquidity support and labor reforms.

"All of these have helped reduce the budget deficit, in particular at the regional level. But the push towards austerity was belated, and Spain seems to have missed its deficit target yet again."

Spain's Budget Minister, Cristobal Montoro said that the Spanish government had committed to reducing the budget deficit, but it would probably miss the budget gap target of 6.3 percent of Gross Domestic Product (GDP) in 2012, a factor that does not bode well for the budget deficit target of 4.5 percent for 2013.

Mariano Rajoy's government has implemented far-reaching spending cuts and raised taxes in order to cut a budget deficit that totaled 9 percent of GDP in 2011.

"This is a problem as 2012 was supposed to be the year of maximum fiscal consolidation," Jha notes. "A lot of the effort [to reduce the budget deficit] has been pushed into 2013 and even the impact of measures taken in late 2012 will be felt more over the coming months, making this year the real test for the Spanish economy, in our view, as the economic contraction intensifies."