"A whale stranded upon the coast of Europe"

A poetic quote coming from Irish political philosopher Edmund Burke referring to Spain. Unfortunately, the quote hasn't lost of its value because the whale has stranded in an economic sense. And it still requires some considerable assistance to find open water again.

Although, despite the huge challenges confronting Europe's no4 economy, today we picked up some good news for the first time since quite a while. It seems that throughout 2010 and 2011, Spain managed to improve its international competitiveness. Eurostat data for instance confirm that Spain's labor cost structure is (-2,6% in 2010 and -1,9% in 2011). Its current account development/trade evolution is also improving in the right direction. The current account deficit - which amounted 10% at the height of the spending spree in 2008 - is expected to narrow to 1% this year and go into the black next year. But regarding international trade, today's numbers reveal some fine details. For instance, Spanish exports last year picked up by 11% and hereby matching Germany's performance. It almost managed to close down its total trade gap and turned a deficit with France into a trade surplus.

One of the ingredients helping out (at least Spain) is a a form of stealth devaluation, evidently not in the monetary sense of the word but in the fiscal sense. Spain has altered its fiscal regime by lowering fiscal burdens on labor cost compensated by raising VAT on domestic consumer goods ; this basically stimulates export oriented production (not so difficult in view of stalling/falling domestic demand) and puts the brakes on imports of final goods. With these numbers in mind, some analysts even dare to predict that Spain has turned the corner and is halfway home. But that is as good as it gets for now because there are still some very dark clouds looming.

It is in fact remarkable that despite these improving numbers - and admitted labor market conditions and the output gap are still pretty worrisome - Spain's recent economic track record has gone unrewarded in the eyes of the international investment community. Looking for instance at the evolution of 10y interest rates and the risk premium versus Germany, the ECB LTRO bonus of the first quarter has completely vanished : we have crossed 6% again with a hefty 4,5% yield differential with Germany. And banks are again coming on the front page. It is not restricted to hidden losses on the loan books (regional cajas have probably not unveiled all of the bad news) but on the functioning of the EMU financial system as a whole. Today we picked up some recent numbers from Target II. This table partially explains why LTRO I and II saw the light late December, relieving the Bundesbank and some smaller players from further direct support. It seems however that after LTRO I and II, things haven't really changed for the better in terms of solving intra-zone funding imbalances :

The numbers above briefly support the view that capital flight and /or difficulties in raising domestic wholesale funding is still problematic for certain countries, not in the least Spain. Which again proves that this financial/sovereign debt crisis is still very much a banking crisis. For Spain an urgent credible solution should really be on top of the agenda if EMU survival still stands a chance.

PS : Moody's will very soon start revising credit ratings of over 100 banks across the globe. This month, Italian banks will get the honor of being examined first, followed by Spain, Austria, Sweden, Norway, the UK and Germany. In June, global capital market firms including US investment banks will pass the review. In an earlier released prelude, Moody's already confirmed that UBS, Credit Suisse, BBVA and Morgan Stanley will most likely be downgraded by 3 notches while JPM, Goldman and HSBC could be cut by 2 notches, stating that "the combination of economic challenges and inherent risk factors have introduced speculative elements into these firms' bonds".

A Pimco analyst briefly concludes :

"Any rating cut could add further misery upon the industry ; it will increase the cost of banks' wholesale funding, trigger margin calls and leave some banks no longer able to borrow from private sources ; which makes it more likely that banks will want to retreat to a loan-to-deposit ratio of 1 ; so further deleveraging is inherently present (further liquidating assets), dragging down the recovery as well. As much as I would like to say that the view of rating agencies don't matter, unfortunately they still do. This is a setback for a lot of banks, particularly when you consider that a lot of them made considerable progress towards Basel III".