There are international investors who are constantly listening to political news. To be able to discern the important from the trivial amidst the noise of social media and media debate, they just need to set digital hooks on certain keywords until they trigger a red flag. Sometimes it doesn’t make much sense or requires the necessary context. So, they go and ask: what is this about debt forgiveness and debt relief? These days it is happening on account of the exchange of proposals in the market that the investiture has become after the elections of July 23.
In the seat auction, ERC and Junts have put a high price on the PSOE so that they take their 14 seats to the green of ‘Yes’ in a hypothetical investiture of Pedro Sánchez. What first was about amnesty -for the fugitive Puigdemont- and referendums -to vote for independence but legally- has turned into a dangerous mission impossible: you take away the regional debt or in the financial jargon of hair). What politicians sometimes knowingly ignore is that what is actually at stake is the money of the investors who lent it to the state. Regional financing has returned to the forefront.
In the eyes of the Generalitat of Pere Aragonés, Catalonia has a regional debt of 71,000 million euros, of which its creditor is the central State through the Regional Liquidity Fund (FLA). You want a discount. It would be the equivalent of the European funds (NextGen) that Spain receives as aid without reimbursement and that are contributing several tenths of growth to GDP each quarter. The interlocutor, therefore, is the Government of Pedro Sánchez. The same occurs for Andalusia (Juanma Moreno) or the Valencian Community (Carlos Mazón) which with 45,900 and 26,100 million, respectively, are the next autonomies with the highest debt to the State.
The problem is that the central government has its own creditors for the public debt and must be accountable to them for how it is used. The must increase today to 1.37 trillion euros (almost 90% of the total debt of the Administrations of 1.5 trillion) to return to the European Central Bank (ECB) -the largest investor since 2020-, private banks, sovereign wealth vehicles, investment and pension funds, insurers, individuals… sovereigns in Spain. Who explains to them that if the government decides to forgive debts, it is actually assuming indirect losses on their behalf?
The forgotten risk premium and more expensive debt
According to the acting Finance Minister, María Jesús Montero, the question of canceling debt “is right now to anticipate a debate that is not yet on the table.” What seems probable is that it will be at some point but hopefully that is not the solution because we will all end up paying for it and very expensive. The FLA was created in 2012 precisely when neither Catalonia, Andalusia or C. Valenciana, among others, were able to go out on the market alone to attract resources by paying debt. Not even the state and the banks until they received the European lifeline. Investors blocked the way or demanded unsustainable interest. The fragility of memory with the most recent economic history is alarming. Unilateral debt cuts inexorably make future financing more expensive.
Debt is not free, although it may seem so to some. The country risk premium is a forgotten index, as was the Euribor during the more than ten years that it has traded at zero or even negative. Now it is once again a nightmare like in 2007 and 2008 for families with mortgages and companies. For this reason, the debate on ‘haircuts’ and debt forgiveness can be a springboard for increasing the financial risk of Spain and its autonomies. Its evolution is still stable in a range close to 100 basis points. For the State, the financing begins to be more and more expensive. The yield on the 10-year Treasury bond traded this Friday around 3.7%, close to its annual maximums and 2014 levels.
The auctions for the remainder of 2023 will continue to make the average rate for the State for its emissions more expensive. Only since 2022 has it become 30% more expensive and in July it will exceed 2% as soon as the statistics are known. In cold hard cash, the annual debt interest bill is on the way to 40,000 million euros. Each percentage point that the average rate rises represents an additional 15,000 million euros a year that must be incorporated into the General Budgets. They feed on taxes, but as they end up running a deficit, this ends up being transformed into public debt and, in turn, more interest.
Spain is no stranger to these dynamics, not even the United States, as we have seen this week. The Fitch agency has downgraded its triple A rating putting its finger on the sore point: the lack of confidence in the government’s fiscal management, the growing debt and the impact that the rate hike cycle will have. The US pays close to 1 trillion only in interest on its debt with an average rate of its total emissions that is barely 3%. The rating marks the reference cost, but the impact of going down from AA with honors to AA+ is presumed to be limited. However, Spain has few steps (Moody’s with Baa1, S&P with A and Fitch with A-) of the red line of investment grade that marks serious problems for the state and its citizens.