(By Fred Dunsel) The Spanish government was put on the defensive last week amid growing concerns over the country's ability to weather the economic turmoil, brought about by the state of its public finances and banking sector. On Saturday, Spanish PM Mariano Rajoy publicly reiterated his government's commitment to stick to austerity measures "as long as is necessary". Finance Minister Cristobal Montoro insisted to reporters that the government's plan to curb its budget deficit was working.
Notwithstanding these public statements, it is widely acknowledged that the euro zone's fourth largest economy is not in good shape. Firstly, Spain's banking sector is feeling from soured real estate investments. The government recently had to spend €19 billion (US$23.4 billion) to rescue Bankia SA. According to analysts, a complete bailout of the Spanish banks would require €50 - €150 billion. Secondly, the country remains stuck in its second recession in three years and is expected to shrink by another 1.7% this year. Thirdly, the country's 17 semi-autonomous regions continued to run high deficits, the main factor behind Spain's 8.9% budget deficit in 2011, which was almost three times the EU limit of 3%. Last week, the rating agency Fitch downgraded the debt ratings of eight regions, further raising their borrowing costs.
As a testimony of the current unease over Spain, the interest rate on Spanish 10-year bonds finished trading at 6.47% last Friday. (A 7% rate is generally considered unsustainable in the long run. Reaching this level was what forced Greece, Portugal and Ireland to ask for bailouts.) Financial markets are also concerned about accelerating capital flight from Spain, whose government is resisting pressure to seek assistance for its ailing banks. Last week, the government revealed that investors had moved US$82 billion out of the country in March alone. Foreign investors have also cut their holdings of the country's debt to 37% of the total, down from about 50% at the end of 2011,
Mirroring the state of Spain's economy, the iShares MSCI Spain ETF (NYSE:EWP) has been on a downward trajectory, having fallen by 49% over the past year. Last week, it fell by 7.4% to close at $21.23.