Spain Re-Coupling to Re-Form PIGS?

As European headlines focused their attention on Greece, Spanish debt yields rose steadily in the last few weeks, bringing the spread versus the German bund to around 250 basis points.

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After it appeared to have successfully de-coupled from the woes of Greece, Portugal and Ireland, analysts are again beginning to speculate whether Spain could soon be in trouble.

“Having given Spain the benefit of the doubt over recent months, the markets appear recently to have become more concerned about the Spanish public finances – something which we have previously warned was likely,” said Ben May, European economist at Capital Economics in a research note.

“Unless a credible, structural solution to the crisis is found then Spain could be about to get back into trouble,” Mark O’Sullivan, the director of dealing at Currencies Direct told CNBC.

The problems in Greece have now turned the spotlight on Spain again, but May believes Spain's problems are of its own making.

“The ongoing uncertainty surrounding Greece has clearly not helped Spain’s cause.
But concerns about the health of Spain’s own public finances have also grown, following news that the Catalonian regional government is refusing to meet this year’s budget deficit goal and growing anecdotal evidence that other regional governments have understated the extent of their fiscal problems,” said May, who sees a number of factors working in Spain’s favor.

“Over the rest of 2011, the Government estimates that it will need to issue 48 billion euro (4.4 percent of gross domestic product) of new medium- and long-term debt and roll over all maturing short-term debt to meet its financing needs for the year,” he said. "What’s more, over the next two years or so, Spain will have to roll over less debt than many of the other peripheral economies.”

With a lower debt as a percentage of GDP than Greece, Portugal and Ireland, May believes Spain could cope with higher interest payments.

“But while Spain may not necessarily be on the brink of insolvency, the Government could still be set for a pretty bumpy ride,” he said.

“Worryingly, if the experience of the past year is anything to go by, once 10-year bond yields reach 6 percent, they tend to quickly climb far higher,” he added.

“In all, then, Spain cannot afford to rest on its laurels. We continue to think that there is a significant chance that it may eventually need to seek outside help to avoid a liquidity crisis," May said. "Indeed, if the Government is forced to inject huge amounts into its banks and the economy suffers from a prolonged bout of stagnation it might eventually need some form of debt restructuring."