Hangover sets in on Spanish debt markets

 A hangover has already set in on Spanish debt markets after a brief celebration over China's promise to buy government bonds despite fears of a 2011 debt crunch.

The rate Spain has to pay to borrow on the debt markets ballooned Friday to 5.543 percent, the highest since at least 2000. Its benchmark 10-year bond closed at 5.526 percent, up sharply from 5.46 percent a day before.

The immediate headache was caused by news that Portugal will join Spain, Greece and Italy in issuing debt in the next two weeks, potentially overloading markets already depressed by the prospect of a spreading debt crisis.

Portugal will be issuing up to 1.25 billion euros in medium to long-term debt on Wednesday, the day before Spain also goes to the market, with Lisbon's own borrowing costs rising to record highs on Friday.

Spanish Prime Minister Jose Luis Rodriguez Zapatero (L) speaks with Foreign Minister Trinidad Jimenez (C) and Industry Minister Miguel Sebastian as they wait for Chinese Vice Prime Minister Li Keqiang in Madrid.
Spanish Prime Minister Jose Luis Rodriguez Zapatero (L) speaks with Foreign Minister Trinidad Jimenez (C) and Industry Minister Miguel Sebastian as they wait for Chinese Vice Prime Minister Li Keqiang in Madrid.

It will be the first major debt market test of 2011 for the weaker European economies of which Spain is a major concern because of its size -- the economy is twice that of Portugal, Greece and Ireland combined.

But analysts say a more serious test for Spain may actually come in April. At the same time, the problem for Spain is not just the financing of sovereign debt but also that of its extensive bank debt.

Spain must roll over 21.79 billion euros of expiring sovereign bonds and bills in April.

A Barclays Capital chart shows hefty bank debt redemptions too, bringing the total of sovereign and bank redemptions in April to well over 30 billion euros. "A difficult spring in Spain," the bank summarizes.

The next big rollover months for Spain's sovereign debt will be July with 20.2 billion euros expiring and October with 23.40 billion euros due.

Spain's central and regional governments and its banks need to raise about 290 billion euros in gross debt in 2011, including rolling over existing bonds that expire, Moody's Investors Service warned last month.

Private investors in bank debt are also deterred by fear the European Union may oblige them to accept less than their promised returns or even an absolute reduction -- taking a haircut in market jargon -- in case of a default.

Chinese Vice Premier Li Keqiang gave Spain a filip during a three-day visit that ended Thursday, pledging to buy more Spanish government bonds and so helping yields to ease.

Beijing has the world's largest foreign exchange reserves at 2.65 trillion dollars but the good news feeling soon passed and investors are already looking worried again.

"Is the debt crisis still a threat? In short, the answer is yes," said a report by Philip Shaw, a London-based analyst at bank and asset manager Investec Securities.

The premium demanded by investors to buy debt in the problem "peripheral" European economies such as Greece, Portugal, Ireland, and Spain has already begun to climb again, he said.

Problems with the European economies were also placing the euro under pressure, said Philip Ryan, analyst at London-based foreign exchange specialists Currencies Direct.

It is "the persistent negative news coming from the eurozone, linked to a feeling that policymakers in Europe are a little short on ideas for getting out of the current mess, that is really keeping the euro under pressure," Ryan said in a report.

"An EU proposal that European banks' senior bondholders should suffer losses on a failure before taxpayers are involved in any bailout was blamed for the initial push lower but news from Portugal of an offering of longer term bonds next week accelerated the move."

Over the longer term, the challenge for the private sector is how to reduce debt levels to sustainable levels.

"It isn't possible for Spain to devalue and have greater exports boost GDP growth. Nor can inflation be created or easily imported to erode the real value of debt," said Barclays Capital.

"This suggests that the bulk of deleveraging will have to be done the hard way -- real credit shrinkage."

Barclays Credit warned that the debt-shrinking process could be long -- "from six years, following the 'short sharp shock' in the Nordic region, up to 18 years in the example of Japan."

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