Will Spain's Luck Hold on Euro Crisis?

As the euro zone crisis has rumbled on, Spain has managed to avoid being dragged into the same trouble as Greece, Ireland and Portugal. If the euro zone debt woes are to avoid becoming a major crisis, that trend will have to continue, and Barclays Capital predicts the luck of the Spanish should hold, unless liquidity becomes a problem.

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“The differentiation that has emerged between Spain and the smaller peripherals in the past nine months, particularly since January, may be tested again in the coming quarters,” Laurent Fransolet, the head of fixed income strategy at Barclays Capital, said in a research note.

With volatility still high, even if it is relatively lower than the peripheral nations of the euro, Fransolet believes the fundamentals remain in Spain’s favor.

“Spain’s debt parameters are more favorable than those of the smaller peripherals: low debt/GDP and limited contingent liabilities,” said Fransolet.

“Overall budget execution has shown little slippage, except for the regions and municipalities, though their overall impact is limited,” he said.

With gains on spending offsetting problems at the regional level, Fransolet believes Spain has a number of key advantages over Greece, Ireland and Portugal.

“A significant advantage of Spain over small periphery economies is that the bond market in Spain is bigger: it is therefore more difficult for indexed investors to just ignore it like they did with the small peripherals.”

“Since the beginning of the year, there has been a clear return of some international investors to the Spanish market. This is on the one hand positive, as investors have shown appetite for Spanish risks after some hiatus,” said Fransolet.

“On the other hand, it clearly means that positions are not as universally short and underweight as they were at the beginning of the year.”

“International investors have had time to differentiate between the various peripherals, though clearly, in a crisis, their most likely behavior is simply to remain on the sidelines and not buy much new Spanish debt.”

With the Spanish banking sector still a concern, Fransolet believes the Cajas (small regional banks) under stress and in need of more capital are better understood and better defined.

The banking sector clearly remains the key concern, although interbank exposures are more manageable than they were six months ago.

“The IPO of Bankia (due before end June) will be a key test in showing the appetite from the private sector for participating in the recapitalization,” said Fransolet.