Sunday, June 15, 2008

Spain's Balance of Payments March 2008

Spain had a current account deficit in March of 12,049.5 million euros, which was well up on the 7.3114 billion euros registered in March 2007. According to the Bank of Spain this deterioration is due to two factors, the increasing trade deficit, and a growing deficit in the income account. If we look at the trend in the current account deficit we will find that in the January to March period (Q1) the total deficit was 32.552 billion euros, while in Q1 2007 the total was 26.637 billion euros. This is a year on year increase of 26.3%. If we now consider the fact that last years whole year deficit was an estimated 105.8 billion euros (or 10.1% of GDP) then if the first quarter trend continues then Spain could well be facing a whole year deficit of something in the region of 130.8 billion euros. (The current IMF WEO guesstimate is 171 billion dollars, or at todays prices roughly 110 billion euros). Now, Spain also has a major economic (credit crunch driven) slowdown underway and it is quite possible that GDP will be nearly stationary this year (let's say a maximum and very optimistic 1% whole year growth), so the value of the the deficit as a % of GDP is set to rise, and possibly very substantially, by between 1 and 2 percentage points. In fact given that Spanish GDP at current prices in Q1 was some 268.496 billion euros, the CA deficit was running at a rate of 12.12% of GDP. And to give us some idea that this way of doing things isn't entirely without foundation, we could note that the CA deficit during Q1 2007 was 24.89% of the whole year deficit. So where we go from here, it seems to me, depends on two things, the price of oil, and the rate of growth of the Spanish economy.

The Trade Deficit

To get some idea where we are here, it is perhaps worth mentioning that the goods trade deficit was up 4.5 billion euros in the January to March period over the same period in 2007 (or an increase of around 25% year on year), and since exports grew 2.4 billion euros while imports were up by 6.9 billion, then we can see that this story is virtually all about one thing: energy imports (since the rising income deficit - up 0.5 billion euros in Q1, or around 7.5% - while important for what it suggests about the future since Spain is having to borrow so much externally to keep afloat, is not determining over a short term horizon).

In fact exports were down in March, but since March was such an untypical month due to the calendar effect of Easter I think we are better staying with the Q1 data for the time being.

The Financial Account

This large deficit in the Spanish current account - which resulted (after taking into account a small positive balance of 223 million euros in Spain's favour on the capital account) in a net financing requirement of 11.8267 billion euros (up from 7.599 billion in March 2007) was basically covered by some very large movements on the financial account.

Spain's net external financial balance with the rest of the world was running to the tune of 17.8778 billion euros in March (up from 5.6969 billion euros in March 2007). This increase in the inflow of external funds is very large indeed (and we will look in detail at some of the ingredients shortly), but the end result was that net assets of the Bank of Spain vis-a-vis the rest of the world was up by 6.8635 billion euros on the month (a very large change from the negative balance of 773.9 million euros in March 2007. Now since things are going so stupendously badly as far as Spain's economy goes, we may well ask why things appear to be going so incredibly well on the flow of funds front. So let's take a look, since the answer we find may well be interesting.

The large increase in the net flow of funds, was mainly the result of a significant increase in the category of "other investments" (which is basically made up by loans, deposits and repos) while there were net outflows on all the other instruments in the account.

Direct investments saw an outflow of 2.3 billion euros, which was down on the net outflows of 6.272 billion euros in March 2007. There were net outlows to the tune of 14.343 billion euros in portfolio investments (largely bonds and equities) which contrasted with the large inflow under this concept 18.142 billion euros in March 2007. If we look at the appetite of foreign investors for Spainish bonds and equities the situation gets even worse, since in March there was disinvestment in Spain to the tune of 12.662 billion euros which compares with an inbound investment of 23.829 billion euros in March 2007.

If we now come to repos, loans and deposits there were net inflows in March of 34.831 billion euros - while in March 2007 there were net outflows of 6.404billon euros. Now we don't have a monthly breakdown of this data, since the Bank of Spain gives this on a quarterly basis, and the last quarter we have is Q4 2007, but as a rough rule of thumb we could say that flows in and out of deposits at banks and other financial instutions are far and away the most important item here (about two thirds of the total, while repos are pretty insignificant at this level).

Basically in March there was a massive disinvestment by Spanish financial institutions in deposits outside Spain - to the tune of 37.911 billone euros (bringing the money home?) which contrasts with net outflows in March 2007 of 18.846 billion euros. On the other hand foreign investors disinvested in Spanish loans and deposits by 3.080 billion euros which compares with inflows of 12.442 billlion euros in March 2007.

Basically something happened in March, but I'm not really sure yet what, and we need to see more data. If we look at the above chart (which contrasts the respective flows by the two agents - internal and external, essetntially the balance doesn't tell you anything more than that it needs to be more or less maintained, and remember negative readings from Spanish agents mean positive inflows since they are disinvesting abroad). Essentially external lending and deposit transfers into Spain suddenly turned negative in March after two months of quite strong positive flows, and as a result Spanish financial institutions ahd to transfer money into Spain, otherwise it seems to me the whole domestic liquidity situation would have been like it was in December (when something similar happened, but the banks didn't move sufficient resources in and bank lending growth came to a virtual dead stop). Essentially as I say we need to see what happens under this heading in the coming months (and the next BoP data is going to be published on 20 June, so we shouldn't have to wait too long), but the volatility that has crept into these flows, and which is evident at the right hand end of the chart is fascinating, and obviously indicative of things we are yet to learn about. What is most clear is how rapidly the Spanish financial agents need to react when external the appetite for lending to Spain slows. I think this may well be one of the clearest indicators we have of the impact of the current account deficit induced money drought.

In Brief Conclusion

Basically I have been focusing in this post on Spain's growing current account funding problem, this issue is basically to do with Spain's lack of competitiveness in exports, and its very strong external energy dependence at a time when oil prices are rising substantially, and when the high price effect looks like it could be long term.

For some time the existence of this problem was hidden by the impact of the housing boom, and by the fact that this boom was increasingly financed by the issue of asset backed securities (ABS, cedulas hipotecarias). Thus during the boom Spain had no difficulty financing its deficit. But times have changed.

The Economist last week had a useful article about the way some banks have been "dumping" (they call the ECB a litter bin) ABS's on the ECB - and this is an issue I tried to draw attention to here. Perhaps the most revealing data point then mention is this one:

"Of €208 billion ($320 billion) of eligible securities created, only about €5.8 billion have been placed with investors, according to calculations by JPMorgan."

So some European banks (and in particular Spanish ones) have been increasingly creating paper for explicit use with the ECB. My feeling is that following all the publicity this issue has now been receiving the rate of new paper creation may well have diplomatically slowed, since if there is one thing Spanish banks don't like to do it is draw attention to themselves (unless of course the news is positive, which in this case it most decidedly isn't).

My general impression is that even the funding that they are currently getting from the ECB is insufficient since it covers only a small part of their needs and hence bank lending is rising at around 5% per annum instead of the 20% year on year rises we were seeing a year ago. So the Spanish banks are really getting starved of cash (or cash at a price which is interesting to them for mortgage lending), and hence all the frantic tooing and frowing we are seeing on the financial account.

Nowhere is this situation more clearly illustrated than in the case of the portfolio investment flows into Spain from foreign investors (basically bonds and equities), and as can be seen in the chart below these underwent a sea change following August last year. This is waht explains all the frantic moving around looking for funds we are seeing, since without the under other concepts Spain could soon become seriously short of money. Basically, if you are sending money out every month to pay for your oil, where are you going to get the funds from for new lending? Desperate situations require desparate acts.

It is my opinion that here in Europe the most serious property issues are in Spain, Ireland and the UK. Spain may well be in the worst state due to the dependence on cedulas, and due to the fact that they need to start rolling these over soon - maybe 40 billion euros this autumn. So they have to refinance and find new money for future mortgages at one and the same time. Not funny.

And of course the Spanish economy is obviously contracting at this point, and last weeks transport strike must have been the last straw in some ways.

But, as we have seen here, on top of the credit-crunch property issues Spain also has a huge CA deficit issue, and the problem is only likely to get bigger if oil prices keep rising. As I say at the start if GDP stagnates AND oil prices rise, then the deficit as a % of GDP (already running at 12.1% remember) may well continue to rise which makes this whole issue unsustainable on its own count.

Spain shares this CA problem with Greece (deficit 2007 13.9% GDP) and Portugal (deficit 2007 9.4% GDP) within the eurozone and these deficits have largely been masked by offering all eurozone data where the large German surplus (surplus 2007 7.6% GDP)obviously covers a multitude of sins. But German citizens are obviously NOT going to pay for Spanish oil (they may lend the money, but how long can this can continue to go up and up is anyones guess, it looks like an extermely exaggerated version of the US funding depence on Japan and China in some strange sort of way).

So basically Spain is headed straight towards a crash on the two biggest global issues of the moment, the credit crunch and oil. The proverbial double whammy. Not pretty!


Anonymous said...

A very good and chilling overview of the economic situation facing Spain. The Madrid Government was in total denial of course up to the March elections and has only just begun to admit the "possibility" of a crisis and recession. This suggests a slow response- or that the government has no idea what to do.
( See and blogs. The sorry situation has been predicted for some time!)

Edward Hugh said...


"or that the government has no idea what to do."

I suspect this is the point. They are either in shock, or still in denial. In fairness I doubt anyone really knows what to do. Meanwhile, as we say here in Catalonia "a fer punyetes" (twiddle our thumbs).