Daniel Lacalle

Exports and Deficits. Two Sides of a Difficult Coin

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This article was published in El Confidencial on February 2013

“Spain Has Potential to Drag Down The Whole Euro Area” Fitch
“The worst is behind us” Barclays

Last week Francois Hollande, France’s president, said that “the Euro crisis has passed” and just as he spoke, peripheral countries’ bond yields soared.

The explanations about the cause of this deterioration after months of euphoria and “success” issuing debt was on one hand, the risk of  Berlusconi returning to power Italy and the fear of an “institutional shock” in Spain due to the accusations of corruption. Those are partially true, of course, but the media always ignores the most obvious reason: Accumulation and saturation of debt in a still fragile Europe.

As always, we tend to overestimate improvements in the funding environment.

We hear banks tell us that investors will buy bonds forever whatever happens “because they cannot put their money elsewhere” and need yield, that there is no need to worry about fundamentals, even if these still deteriorate. It happens every year around January-February.The problem is that after the euphoria we get the surprises, because the problems are the same. Rather than taking the opportunity to take aggressive debt reduction actions when market conditions relax, countries max-out the credit card. In any case, citizens pay.

Appetite for risk is not eternal and unconditional.

One thing is to see a temporary period of risk appetite and another one is to take it as a reflection of a fundamental improvement.

This week I met with various international funds and all said the same thing. Sure, they are willing to include certain peripheral exposure in their portfolios. That’s good. But not more than 20-25% of their total holdings. This is standard prudence and risk management, which our politicians ignore.

But nothing is easier to believe than expected fund flows, that investors will ignore the macroeconomic difficulties of a country because they “have no choice” to get some yield. And the last seven years prove otherwise.

But politicians say exports are going to get Spain and Europe out of the hole. All of Europe?All the countries we analyse expect to increase their exports in 2013 and 2014.

The major change in trend of all eurozone economies is supposed to be exports. This is what we hear everywhere. In all countries we follow. Challenging.

However, Euro area exports declined by the most in five months in December 2012. Exports for the quarter as a whole were 1.6% lower than in Q4. German exports tanked 3.4% m/m in December, France -1.5%, while flat in Italy and in Spain.
We should be cautious. Exports account for 30-32% of Spain’s GDP. Even if these increased by 10%, it means only about 35 billion euros of revenues, less than half of the country’s net financing needs. That is, the accumulation of debt and deficits more than offset the improvement in exports. Additionally, the remaining 70% of GDP is in contraction (internal demand down 3.3%).Spanish officials say the number of exporting companies has grown by 12%. True, but the vast majority of exports (90% of total) are concentrated in a limited number of companies (10% of all), according to BBVA. That is, if one of the large companies slows down, growth expectations dissipate. And none of the companies that have posted results so far have announced an increase in sales abroad for 2013.

European countries’ debt continues to grow. In 2013 we expect an additional 1.5 trillion euros.

Spain has missed all its deficit targets since 2008 and will likely miss it again and end 2012 at 7% -plus another 1% of subsidy to banks and others. Added to this 8% deficit of 2012 after spending cuts and tax increases, the most optimistic forecasts assume a 5% deficit in 2013. Both combined are about 145 billion euro more of debt. Meanwhile, GDP expectations move between -0.5% and -1.4% for 2013, and unemployment to hover around 26.5%, as tax increases prevent any chance of recovery, when domestic demand is expected to fall 3.8%.
If the government really wants to help the economy with exports it cannot keep spending and offset any positive effect created by internal devaluation.What is the biggest problem for bond yields? That deficit will likely be revised upwards between February and April. First, to include the “one-offs”, then by GDP revisions. And then, markets could question the 2013 targets.

Is it impossible to solve?

If Spanish regions like Castilla la Mancha, the Basque Country, Madrid and La Rioja and others have been able to comply with their deficit targets in harsh environments, the Central State and the rest of the regions also can. And they should.

If they don’t, unemployment goes from being a problem to be a structural issue, because taxes will go up again, sinking any recovery possibility.

The adjustment of the public and financial sector, and slashing unproductive spending and subsidies is the solution to a debt problem that stifles the potential to generate jobs and growth.
The crowding out effect of the State in the economy is very evident in Spain, as we mentioned here, but even if it is reduced, it is very difficult to see credit to the private sector return due to the sheer weight of existing zombie loans. In the UK, for example, credit has not fully recovered after seven years.Let’s hope for the best but prepare for the worst. Just in case.

I know. Politicians say that economists cannot predict cycle changes and that by 2014 growth will return … but by then Spain’s debt to GDP will have skyrocketed to 110%.

Would it not be better to do our homework instead of expecting miracles and fund flows that do not depend on us?

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