Closer to Rubicon crossing

I have previously argued that Spain is the game-changer for Eurozone debt crisis. If Spain fails, it will be the Lehman of debt crises, because rules of engagement will be unknown, and panic will spread across the globe riding on a giant uno-correlation machine. This is why EU, ECB, and likley G-20 will do all that they can to jump ahead of the crisis, as EFSF and like simply do not have enough fire-power to stem a run on Spain. I still think that a Spanish default or equivalent is far away, but today’s downgrade of Spain by Moody’s shows that we are moving closer to this terrible possibility.

Here are the key reasons for the downgrade, according to Moody’s –

#1 – Recapitalization of cajas will likely cost Spain €40-50 bn, more than double previous estimates by Moody’s and €18 bn estimated by the Spanish government. Why? One, because the capital requirements have changed–core capital ratio of 10% as opposed to 8%. Second, eligible securities for capitalization have also changed, making it harder to reach the same %age.

#2 – Central government has limited control over the 17 regions. Plus, this year’s budget deficit target is 1.3%, which will be harder to achieve, give that last year, 9 out of the 17 regions breached the budget deficit target of 2.4% . Plus, most of the improvements last year came from unsustainable cuts in spending–pay freezes. Moreover, no new deficit initiatives have been announced.

#3 – Modest acceleration in GDP, so the deficit cannot be addressed by more tax revenue.

There’s something positive in Moody’s release, though –

“At around 60% of GDP in 2010, Spain’s public debt ratio is lower than that of several important peers, including Germany, France, the UK, Belgium and Italy. Even including the higher estimates for bank recapitalization, Spain’s debt ratio would remain lower than those of Italy (Aa2, stable) and Belgium (Aa1, stable). Moody’s continues to believe that Spain’s debt sustainability is not under threat, and its baseline assumptions do not anticipate a need for the Spanish government to ask for EFSF liquidity support.”


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