Inconclusively Iberian

Tony Barber paints a melancholic picture of Spain's waltz towards aid although the results of a relatively successful auction may beg to differ. Spain's 859 million euro 10 year auction drew an average yield of 5.66% - almost a 100 basis points less than last month. The 3.9 billion offering on 3 year notes drew 3.845%.

That's the Draghi effect for you. The ECB's OMT pledge bought Spain an almost unimaginable amount of relative time to resist a bail-out. The problem is that Spain sits on the junk-bond cusp for Moody's and while safe from an S&P downgrade, is also on the investment-grade cusp at Fitch. A slash here or a slash there could sharply precipitate bond-yields and throw Rajoy's government into an immediate quandary. 

Come on, let's face it. No on really believes that Rajoy can defy fate for much longer when the heavy burden of under-capitalized banks, unfavourable debt dynamics, no growth and almost mass unemployment weighs heavy on his crown. Skip the talk of banks and bonds and you arrive at the more serious matter of regional friction, political disarray and social discontent. 

A large factor is the national pride and perception of sovereignty yet Rajoy has all but admitted to resisting aid unless borrowing costs increase again. 

If I was the ECB, it would make sense that the OMT pledge succeeded in one short-term respect. It bought Spain enough time to figure out what kind of aid they could use without seemingly compromising all and sundry. It doesn't have to be a strict, comprehensive package, maybe a flexible credit line. The important aspect is the relative ebb of the current waters. Should the tides rise again, stiffer consequences will naturally accompany stiffer conditions.

As the IBT reports,

"Critical to Spain's ability to use the time bought by the Draghi Effect to avoid a bailout will be its plans for the funding and budget needs of its 17 semi-autonomous regions, which collectively contribute to nearly a fifth of Spain's overall debts and more than a third of its annual deficit.

Spain's federal government has set up a domestic rescue fund of around €18bn to help the regions refinance maturing debt, but a good portion of that funding comes from Spain's troubled banking sector, whose debts are among the highest - at 340 percent of GDP - in the whole of the Eurozone."

And there's the matter of regional impasse with Catalan requesting a few billion in assistance as well as more fiscal self-authority which poses a heads-on conundrum to an equitable distribution of any potential aid. 

Spain's socialists, in power when the bubbles began to burst, are naturally vehemently opposed to any sort of a rescue, which they say would "affect the Spain brand" and force citizens to make further incomprehensible sacrifices thus placing additional pressure on the Rajoy government that quite frankly, they could do without. 

On September 28th, a stress-testing for Spain's banks will be complete and their capital deficiencies and requirements will be further brought to light. This fleeting warmth is uncomfortable at present but if the majority of factors start trending in unfavourable directions, they may well give rise to a scalding heatwave from which escape without serious repercussion may be too difficult.

(40.2, 53.9, 61.2 and 68.5 are Spain's General Govt Debt as a % of GDP for '08-'11. g is the year on year growth rate for real GDP while r is the interest rate on a 10 year Spanish bond discounted by the average inflation rate.)