The Spanish economy is headed for a second major recession in five years and it does so in a dramatic financial context that even puts the financing of the state and the autonomous regions at risk. 

This is now not only affecting the private sector, which has been the case so far, but also the public sector that until now – although at high rates – has been financed through the markets or through injections of liquidity by the European Central Bank.

The tougher financial conditions are explained by the deteriorating economic activity, according to the updates of the World Economic Outlook report published by the International Monetary Fund on Monday, but it is also related to the massive capital outflows from Spain.

According to the IMF report, Spain’s economy is expected to shrink by 1.5 percent in 2012 and 0.6 percent in 2013.

ECB refinancing not enough

The IMF points out that despite the ample liquidity provided by the ECB's refinancing operations (almost a billion euros at three years), "funding conditions for many peripheral banks and firms have deteriorated.”

This particularly affects Spain and Italy, where investor fear –in line with what the ECB has suggested– that bondholders will also suffer from the consequences of a hypothetical default, which is a risk also for senior bondholders.

The IMF recalls that, specifically the interbank market remains closed, while, at the same time, there has been a capital flight to safer assets in the United States, Germany or Switzerland, which has led to the highest appreciation of the dollar in 20 months, while the Japanese bond yields fell to historic lows. Within the European Union, Sweden and Denmark have also become ‘safe’ destinations.

Tougher monetary conditions

According to the IMF, bank bond issuance "has dropped off precipitously, with little investor demand even at higher interest rates.” This has forced banks in the Eurozone periphery into the hands of the ECB. In the case of Spain by as much as €337bn, which is seven times more than a year ago.

The tougher monetary conditions, which are consistent with the increasing risk aversion, come at the worst moment for the Ministry for the Treasury, as well as for the autonomous regions that will have to meet the needs for further debts during this year. The new state fund that will be installed to help refinance the regions does not seem to be enough.

A longer version of this article is available in Spanish here.

This article was translated and edited by Stina Lunden.