Spain, not Greece, may be the biggest eurozone threat - FT.com

Spain, not Greece, may be the biggest eurozone threat - FT.com

By Charles Dumas - 20110921

Greek default is the high-profile threat to eurozone banks that hogs the headlines, and drives down the share prices of the region’s banks. But, aside from the Greek banking system itself, Greece is not a major threat to European banking solvency.
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To get a fuller measure of the burden that may fall upon the state’s resources, we need to add a country’s household and net business debt to net government debt as these will have to be serviced in some fashion from that country’s income. By this broader definition, Italy comes off relatively well, with total debt a little over 200 per cent of gross domestic product. Greece at nearly 230 per cent is less bad than Spain, as well as Britain and Japan. Way out on their own, however, are Portugal at over 300 per cent, and Ireland at 330 per cent. Diana Choyleva and I in our latest book* explain why this means the credit of Portugal and Ireland, and probably Spain, could well become more threatened than Italy – though not as badly as Greece, which has particularly acute government debt and deficit problems.
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In Portugal, non-financial companies (NFCs) have debt that is 16 times their pre-interest profit. An interest rate of little over 6 per cent would wipe that profit out. In Spain the numbers are 12 times and 8 per cent, respectively. So its entire NFC sectors are junk – a designation that kicks in at a ratio of about 10 times. The somewhat less dire Spanish ratio is exactly where Japan was in 1995-96. Japan had no real GDP growth between 1996 and 2002 – an ominous precedent – and finally emerged into growth again after a massive bank-debt write-off in spring 2003.

But Spain’s current situation is in several respects far worse than Japan’s back then. First, Japan had a currency, which devalued in real terms by 20 per cent over the six years to 2002, aiding adjustment. Spain is fixed in the euro.
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