Well that so called investor "risk appetite" took a surprise hit yesterday (and from an unexpected quarter). It wasn't the worries about US fiscal deficits that caused the panic, but problems in the European banking system. Gwen Robinson reports:
Risk appetite suffered a sharp deterioration on Monday as fresh uncertainty about the global economy prompted investors to shift from equities, commodities and emerging market assets into the perceived safety of government bonds and the dollar. Markets were further unnerved by warnings on the economic outlook from the head of the IMF and an ECB report saying eurozone banks face another $283bn in writedowns on bad loans and securities this year and next.
As Izabella Kaminska notes, it is Southern Europe that is now getting all the attention.
This time it’s the turn of 25 Spanish banks, all of whose senior ratings were on Friday downgraded by Moody’s. Banco Santander, of “we’re so strong we’re actually going to expand through the crisis” fame, meanwhile, remains under review for possible downgrade.......
Also, this one in Bloomberg:
A Spanish fund planned to aid lenders will be set up with 9 billion euros ($12.6 billion) and will have the capacity to raise an additional 90 billion euros in debt, Finance Minister Elena Salgado said. The government is still working on the details of the plan, which will need the approval of parliament, Salgado told a news conference in Madrid today after a weekly Cabinet meeting. The government would raise the initial 9 billion euros with a debt issue, she said, adding that there was “no hurry” as “there is not one entity in difficulty.”
As unemployment and bankruptcies surge, bad loans at Spain’s banks rose 4.27 percent of total credit in March, the highest since 1996, compared with 1.2 percent a year earlier.
But as Isabella detailed: "Moody’s also noted that a significant government capital injection - which apparently has been discussed for some time now by the Spanish government and the banking sector — could prompt subsequent upgrades of some BFSRs. "
And guess what else it might prompt, more downgrades in Spanish sovereign debt, that's what it might prompt. Economy Minister Elena Salgado was widely quoted in the press last week, giving an estimate of 9.5% total fiscal deficit for 2009 (not bad my guess of 9% back in February, I think). But they are still hoping for a contraction this year of only minus three percent, and this seems very optimistic, so the outcome will surely be a deficit in double figures.
This, in my view, is the last year that the financial markets will pardon such a deficit from Spain, and we will now be under fiscal pressure as well as relative price pressure. Essentially, I agree with Krugman (or should that be, given the NYT links, Krugman agrees with me) and what we need in Spain is an "internal devaluation" of about 20% to jumpstart the economy - and this is 20% vis a vis Germany, where they are also having deflation, so the size of the correction is very large. And at this point - August will mark the second anniversary of the commencement of what looks like becoming Spain's "lost decade" - we haven't even started.
And Greece is also moving towards centre stage, as the FTs Kerin Hope details in this article:
After a decade of explosive loan growth triggered by Greece’s entry to the eurozone, the country’s banks are experiencing the downside of a financial cycle for the first time as the economy stutters in the global downturn.
Exports are declining, the tourist season has got off to a poor start and the Greek economy is projected to shrink by about 1 per cent this year, according to the International Monetary Fund. Years of excessive spending have pushed up the public debt to almost 98 per cent of gross domestic product.So far the banks have shown some resilience, assisted by a €28bn government support package that included a €5bn capital injection in preferred shares, and there have not been any government bail-outs of individual banks.........
However, the situation may be about to worsen with analysts forecasting bad loans will rise this year from 3.8 per cent to about 6 per cent before peaking in the first half of 2010. Meanwhile, Fitch, the ratings agency, last week warned the banks’ performance for the rest of the year would likely be hit by higher loan impairment charges.
So the world seems to work like this. Latvia gets battoned down for a few months via a few billion in loans from the IMF and the EU Commission. As a result, the Baltics now become yesterday's story - till they aren't again, of course. And we move on, as I more or less feared, and its time to begin to focus on Southern Europe again (while Eastern Europe deteriorates sufficiently to make it back into the headlines). I think people can only keep so many things in their head at any one time.
Basically the whole EU system seems to be in denial on what is happening at the moment. The markets have been focused on the East, but they are now starting to wake up to the fact that the South is still here, and when this "matures" we will have a full blown financial crisis, that is for sure. At that poiunt the Spanish and Greek governments will effectively lose control of the situation, just as they have done in Latvia and Hungary.
This is one of the reasons I am following Latvia closely. Basically what is happening in the East is a sort of "dry run" for what is going to have to have to happen in the South. The whole package, from "fiscal austerity" as a tool to attack recessions, to "internal devaluation" via price and wage deflation is about to be applied in the South as a path towards restoring export competitiveness and economic growth.
There has been a lot of talk, of late, about the contagion danger from Latvia, but few seem to consider the possibility that - given the way the EU itself is putting its credibility on the line in the Latvian case - if finally Latvia folds (and devalues, as I feel it must), then the contagion problem could leap straight to the South from the East. Obviously Romania is looking very vulnerable to anything that happens virtually anywhere, but Spain looks a lot more vulnerable to me at this point than either Poland or the Czech Republic, due to the massive external financing requirement.
Basically investors have now started to remember that Greece and Spain still exist. I suppose we will now see the crisis zigger-zagger across from the South to the East and back again, with the German real economy receiving body blows on both counts in the middle.
Meantime in Berlin and Frankfurt they seem to be mainly worried about the US fiscal deficit at this point. Stange what makes people tick.
