Risks Rising for Troubled Spain: Citi

With the Greek debt issue finally off the agenda following the completion of its debt restructuring and the euro zone still basking in the glow of the European Central Bank’s long-term refinancing operation, which pumped a trillion euros into the banking system, attention has turned to Spain’s finances.

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Having fallen sharply following the ECB’s intervention, Spanish borrowing costs have inched up in recent weeks on fears that Spain’s regional governments, property market and banking system could affect Spain’s debt dynamics and make Madrid the latest target of the bond vigilantes who have taken a breather from selling euro zone peripheral bonds.

Over the weekend Mario Monti, the Italian prime minister and key ally of German Chancellor Angela Merkel warned that Spain risked re-igniting the euro zone debt crisis. "It (Spain) certainly made profound reform of the labor market but it did not pay the same attention to public finances," Monti said on Sunday, though he has since backed off that statement.

Monti’s comments are likely to be confusing to investors, but one leading economist believes Spain could find itself in trouble if it does not take more aggressive steps to restructure its economy.

Sovereign debt restructuring is avoidable but would require more radical fiscal and structural measures,” Citi Chief Economist Willem Buiter said in a research note on Wednesday.

With government, households, companies and the banks looking as if they’ve borrowed too much, according to Buiter, the the risk of Spain getting into trouble rising.

“Losses are likely to mount for the fragile undercapitalized Spanish banking system as a result of falling property prices. The Spanish authorities may not have the resources to adequately recapitalize their banking system,” said Buiter, who believes the new Spanish government has wasted an opportunity to cut government spending during its first 100 days in power and annoyed German officials in Berlin and at the ECB .

“We think the decision by the new government to limit the degree of pro-cyclicality in its fiscal policy was right in substance. The manner in which it was taken and announced was unlikely to have been popular in Brussels and Frankfurt,” he said.

“Spain looks likely to enter some form of a troika program this year, as a condition for further ECB support for the Spanish sovereign and/or Spanish banks,” Buiter said, making a reference to the combined effort of the International Monetary Fund , the European Commission and the ECB to at least temporarily bring confidence to markets on Greece’s financial future.

Spain's Finance Minister Luis de Guidos said Wednesday afternoon that the Citi report was "out of place."