Why Spain is different
Every five months since early 2010, a fiscally-challenged euro area country has had to seek EU-IMF financial assistance.
Greece last May, Ireland in November, and now Portugal. However, the recent market moves appear to indicate that this trend may be coming to an end. In the very same month that the Portuguese bond yield surged by 100 basis points (bp), the Spanish one declined by 20bp.
As a result, despite being considered next in line for a bailout, fears of contagion to Spain have eased. The reason is threefold. First, the rebalancing of the Spanish economy away from domestic demand has started, thanks to the strong global growth and a material improvement in the public deficit. Second, despite having doubled since 2007, Spain’s public debt remains low, even below that of Germany. Finally, Spain appears less vulnerable to a sudden shift in overseas risk perceptions as foreigners only own 44 per cent of the local bond market, compared to 93 per cent in Portugal or 82 per cent in Ireland, though this is still much higher than in the UK.
However, Spain does not appear completely out of woods, mainly as the cost of the bailout to save banks which represent 40 per cent of the banking sector may well spiral out of control. Moreover, with the regional government deficit expected to reach five per cent of GDP in 2011, and both regional and general elections looming, the political risk remains high.
Despite these large uncertainties, the ECB has almost halted its bond purchase programme, and has decided to raise interest rates for the first time since 2008. However, it is seeking to establish a ‘separation principle’, by which it continues to provide liquidity to the banking sector, but at ever higher costs. But separating the quantitative from the easing is highly experimental in itself, and the inherent contradiction in these policy levers suggests the ECB might have to backtrack in the future – all the more so if Spain (the fourth largest euro area economy) becomes at risk of falling under the EU-IMF umbrella.
For charities, many fund managers will have been trying to enhance the yield on their investment portfolios by buying overseas bonds. Portuguese government issues might have looked very attractive three months ago, with five-year bonds yielding six per cent, some 3.9 per cent more than German bunds and 3.5 per cent more than UK gilts. However, with the benefit of hindsight, with yields now at 9.2 per cent and capital values about 13.5 per cent lower, this will not have looked like a clever investment! That said there is nothing wrong with trying to add value by buying overseas or indeed corporate bonds (one could have made significant returns buying Canadian government or insurance sector bonds over the past 12 months). However, charities should be aware of the risks fund managers are taking on their behalf and be comfortable that they are suitable and in keeping with their particular risk and return objectives.
Yvan Mamalet is an economist at Sarasin & Partners LLP
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