Commercial awareness: think like a professional about... the Spanish economy

Our banker, lawyer, accountant and consultant take a look at what's going on in this troubled southern European economy

As the summer months approach, thoughts often turn to holidays. For northern Europeans not blessed with a Mediterranean climate, Spain has traditionally been a popular destination. However, the Iberian nation has recently been getting attention from across the continent and beyond for quite different reasons.

The government of Spain, like that of most other countries, raises funds through the issuance of government bonds for various periods of time, known as the bonds' terms. The interest rates and the price of these bonds vary according to market demand, with a high interest rate broadly representing a view in the market that the issuer is at high risk of defaulting, and vice versa. Recent rises in the interest rates of Spanish government bonds suggest there is currently significant anxiety about the Spanish economy in the market. At one short-term bond auction held by the Spanish government, rates for 12-month and 18-month bonds almost doubled from those on offer at an auction a month previously. Rates for some 10-year bonds have soared above 6 per cent, a borrowing cost which is thought to be unsustainable long-term. These rises reflect severe long terms problems in the Spanish economy.

Before the financial crisis hit, Spain appeared to be in good financial health compared to many other European countries. In 2007, government spending was well under control - Spain's debts represented 36 per cent of GDP (compared to Germany's 65 per cent) and it had a budget surplus (Eurostat). Its banks were solid and well-respected. The country boasted thriving real estate and tourism industries.

However, from 2007 onwards, the nation was hit with a number of severe interrelated economic shocks. The global economic downturn led to a dramatic drop in demand for real estate and tourism facilities, leading to reduced spending and to severe strain being placed on the nation's banks, which had provided the money to fund the growth of these now-crippled industries. As a result, the Spanish government has had to borrow heavily through the bond markets to prop the banks up and keep the economy functioning. Furthermore, rapidly increasing wages during the boom years mean that the cost of producing goods and providing services in Spain is now very high, making them expensive to export and thus limiting the amount of money flowing into the country from outside. If it had its own currency, Spain could devalue it against its trading partners' currencies, so making its goods and services cheaper, but its membership of the eurozone precludes it from doing so. Finally, those managing Spain's economy have also had to deal with its ongoing structural weaknesses, particularly a tendency towards high inflation, a large unofficial economy and a relatively poor education system.

Key economic indicators suggest things are now very bleak indeed for Spain. The nation has a large budget deficit and its economy has recently dropped into recession. Most striking is its unemployment rate, which is the highest in Europe at around 24 per cent in the general population and, shockingly, stands at over 50 per cent for people under 25. A severe austerity programme, brought in 2010 and to which new prime minister Mariano Rajoy Brey is committed, will eventually help to reduce the budget deficit, but will do little in the short term to encourage spending and stimulate economic growth. And similar programmes in other European countries to which Spain exports, including the UK, will also hamper the nation's recovery.

As with Greece, an exit from the eurozone and the reintroduction of a weaker national currency remains a theoretical last resort option to help solve some of Spain's economic problems by reducing the cost of its exports and boosting its tourism industry by making the country cheaper for foreigners to visit. However, the practical and political difficulties associated with such a step mean that it isn't on the cards for the near future at least.


  • Uncivil war: Here in the UK, the coalition government has brought in some employer-friendly changes to statutory employee rights in order to encourage companies to take on more workers. And new Spanish prime minister Mariano Rajoy Brey, who was elected at the end of last year, is doing something similar in Spain, passing laws making it easier to reduce employees' wages and dismiss them. Spanish unions have responded angrily with strikes and demonstrations, some of which have turned violent. Worryingly, the Spanish government have resorted to some heavy-handed laws passed during the repressive rule of dictator General Franco in an attempt to suppress civil disobedience, and is considering making the law in this area even tougher.
  • Law unto himself: Rajoy is no stranger to law and order, however, as he's a lawyer himself. Born to a father who was a judge, Rajoy studied law at university, then moved into the Spanish civil service to become Spain's youngest ever property registrar before beginning his political career in earnest.


  • Accentuate the negative: They say you should judge a person by the company they keep, which I think applies to countries too. The significance of Spain's dramatic shift from budget surplus to deficit as the effects of the financial crisis set in (from 1.9 per cent of GDP in 2007 to -8.5 per cent in 2011 [Eurostat]) is underlined if you look at the change in the countries with similar surplus/deficit numbers. Spain's 2007 figure indicated an economic footing similar to that of prudent Estonia or Sweden, while its drop into the red in recent years puts it up (or down...) there with troubled Greece and Portugal.
  • Underground action: Spain has one of the EU's largest underground economies, which means those economic activities which are not picked up through official channels and therefore not taxed, for example, workers taking on unofficial employment for cash in hand while continuing to claim unemployment benefits. The Spanish government is proposing a number of measures to bring such activities under official regulation, including forbidding large cash payments. It sounds like it's worth doing, as economists have estimated that these kinds of illicit and currently untaxed business dealings could be represent as much as a fifth of Spain's economy.


  • In and out: Countries have "brands", just like individual corporates, and if there are whispers that all is not well, their value can decrease rapidly, with significant financial implications. Since last summer, thanks to rumours that Spain could exit the euro, the value of the Spanish "brand" has decreased with lenders, leading to a rush out of Spanish companies and into "safer" investments. Why are lenders so scared? A return to the peseta in Spain could see euro loans made to Spanish borrowers redenominated in pesetas, leading to a significant losses for lenders as the peseta would quickly drop in value again the euro.
  • Go west - and east? Thingsmay be looking up for the Spanish export sector. At the end of 2011, the OECD predicted steady export growth for Spain over the next few years. Particularly promising are the strong economic relationships Spain has with many growing economies in Latin America, thanks to historical and cultural ties, and it's now the biggest foreign participant in these economies after the US. I'd advise Spanish companies to also look to developing Asian markets, where there's potential for them to grow their currently small presence significantly.


  • Hay problema: There's not much political will at the moment to take Spain out of the euro, so I'm wondering what its other options are if things take a turn for the worse - and with the high borrowing costs that its bond interest rates represent, they may well do so. The European Central Bank (ECB) could purchase Spanish government bonds, so increasing competition in the market for them and bringing their interest rates down. There's also the possibility of Spain getting a bailout, like Greece, Ireland and Portugal have done, though the eurozone's resources can only stretch so far...
  • Bank on it: Spanish banks have had their ups and downs over the past few years and are looking a little shaky at the moment. But they've traditionally been seen as some of the more stable ones within the industry, as the rules to which they're subject on how much capital they have to put aside to protect them against bankruptcy are stricter than in many other countries. For a prime example of this strength, in the past at least, remember how Spanish bank Santander was able to snap up suffering British banks Bradford & Bingley in 2008 and Alliance & Leicester in 2010.