The Spanish Economy and The European Crisis
Rafael Doménech
CFA Spain Academy for Financial Journalists June 27, 2012
The Spanish Economy and The European Crisis. June 2012
Page 2
Section 1
International environment: continued global growth and the European Crisis Section 2
The Spanish economy at a crossroads
Contents
The Spanish Economy and The European Crisis. June 2012
Page 3
Europe decoupling from global growth
GDP growth (% yoy) Source: BBVA Research
The debt crisis continues, with Greece under the spotlight and concerns about Spain
High levels of financial stress in Europe, with a risk of credit restrictions
Stability Treaty: towards Maastricht 2.0. More emphasis on growth
Expansive, but no homogeneous, monetary policies by the Fed, the Bank of England and the
ECB
A slow, heterogeneous and vulnerable recovery
3.64.0
-‐0 .2
0 .9
2.3 2.2
5.86.4
-‐1
0
1
2
3
4
5
6
7
2012 2013 2012 2013 2012 2013 2012 2013
Global EMU USA EAGLES
May-‐12 Feb-‐12
The Spanish Economy and The European Crisis. June 2012
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The European crisis continues
Signi!icant progress... ... but still with challenges ahead
To date, the authorities have been a step behind the events à half measures to overcome the crisis
Restructuring of Greek debt and bringing forward the ESM
Long-term ECB liquidity provision
Reforms in Portugal, Spain, and Italy
Approval of the Stability Treaty
1. Access to financial markets
3. Growth agenda
4. A clear road map towards a fiscal union and financial integration
2. Need for e"icient firewalls: Spain financial assistance and others
The Spanish Economy and The European Crisis. June 2012
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BBVA Financial Stress Index Source: Bloomberg and BBVA Research
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
USA EMU
The European crisis continues
The Spanish Economy and The European Crisis. June 2012
Page 6
1. Access to !inancial markets
Differences in interest rates and the dependence on the ECB: two sides of the same coin
Reducing financial tensions: a precondition for the success of fiscal adjustments and structural
reforms
The need for a political agreement
Interest rates and TARGET2 Source: ECB and BBVA Research
The Spanish Economy and The European Crisis. June 2012
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2. Need for e"icient !irewalls
.
The !inancial assistance to Spain is a positive step …
The EUR 100bn of financial assistance is a su"iciently high backstop, announced before
the results of the stress tests
Removes uncertainty about funding sources and increases the credibility of the restructuring
process
It differentiates Spain from the cases of other peripherals like Greece, Portugal or Ireland
… that should be complemented with additional European measures
Breaking up the correlation between sovereign and banking risk (SMP by ECB, EBA, …)
E"icient use of available resources by the ESM to anchor markets expectations about the euro
and risk premia
Short-run measures consistent with long-run objectives
The Spanish Economy and The European Crisis. June 2012
Page 8
What is needed? What is the reallity?
Clear roadmap to completely remove the expectations of an euro break up
A roadmap with a credible strategy for long-term growth
Banking union and direct capital injection from ESM
Meeting fiscal targets to reduce the increase in debt
There are major disagreements between members. A winding road
No news
Backstop + credibility … details still pending
Public debt increases and doubts about preferred status of EFSF/ESM
Rick premium
Exchange rate
Growth
Banking restructuring
Fiscal policy
2. Need for e"icient !irewalls
The Spanish Economy and The European Crisis. June 2012
Page 9
3. Growth plan
Clear route map for the future of EMU
Balance between growth and austerity: reforms in exchange for a growth strategy
Short-term objective: to avoid the risk of an austerity-recession vicious circle and the doubts regarding sovereign debt solvency
Gradual fiscal adjustment with multi-year plans. Focus on structural deficits as the Treaty proposes
A growth plan that complements !iscal adjustment
The Spanish Economy and The European Crisis. June 2012
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4. A clear road map towards a !iscal and !inancial union
EFSF & ECB ESM European Treasury Eurobonds
Very short run Short to medium run
Long run
EFSF Governments
ESM Banks
European banking union
Very short run (if ESM not ready)
Short to medium run
Long run
The Spanish Economy and The European Crisis. June 2012
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4. A clear road map towards a !iscal and !inancial union
A !iscal union
Eurobonds: a convenient mechanism for mutualising risk
The "blue" and "red" bond proposal ensures a degree of market discipline
In the mean time, the ESM could be more e"icient reducing the volatility of risk premia
A banking union
A single rule book and European supervisor
A single European Deposit Guarantee Insurance System
A single European rescue fund
The Spanish Economy and The European Crisis. June 2012
Page 12
Section 1
International environment: continued global growth and the European Crisis
Section 2
The Spanish economy at a crossroads
Contents
The Spanish Economy and The European Crisis. June 2012
Page 13
Main changes in the economic scenario for 2012
Factors determining the economic scenario Source: BBVA Research
New
fact
ors
Growth forecast in January
New scenario -1,3%
3. Higher financial tensions
4. Fiscal adjustment due to the 2011 deviation from target
5. LEP and Government Commercial Debt Program
6. Labour market reform
-1,3%
1. New available information in line with our scenario
2. Higher oil prices
The Spanish Economy and The European Crisis. June 2012
Page 14
Available data con!irms the scenario
Spain: real GDP growth and forecasts based on MICA-BBVA model (%, qoq)
Source: BBVA Research Current forecast: 4 May
The Spanish economy entered technical recession in 1Q12...
Employment continues to be hindered by the negative outlook for growth
Published data indicates that 2Q12 growth is likely to have remained negative
...albeit with no acceleration in the rate of deterioration versus 4Q11
CI at 60% CI at 40% CI at 20%
MICA-BBVA point estimation (21% of data for 2Q12)
Actual (BBVA Research o"icial forecast for 2Q12)
-1.5
-1.0
-0.5
0.0
0.5
1.0
2Q0
9
3Q0
9
4Q0
9
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5 1.5
The Spanish Economy and The European Crisis. June 2012
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Increased !inancial tensions
The di"iculties to reach the 2012 and 2013 deficit targets. The fear that fiscal austerity may lead to a vicious circle
The potentially higher cost of bank restructuring as a result of the adjustment in the real estate sector and the slower growth
The idea that both Europe and Spain have lacked a medium and long-term strategic plan
The higher amount of sovereign debt on banks' balance sheets: negative interaction between sovereign and banking risks
Despite the ECB liquidity, the progress being made in Europe, and the reforms in Spain, markets are still cautious due to:
The Spanish Economy and The European Crisis. June 2012
Page 16
General government: budget balance adjustment (pp of GDP) Source: BBVA Research based on MINHAP
In a no-policy change scenario, the deficit would increase by 1.9 pp of GDP in 2012
Significant cyclical deterioration in 2012
The discretionary measures needed amount to more than 5 pp of GDP to reach the target
of -5,3%
Already announced 4.7 pp. Additional asset sales could help reach target if needed
Fiscal de!icit: the challenge for 2012
Unobservable components model results
3.6
2.3
0.4
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2011 (Deficit: 8.9%) 2012 (Target: -5.3%) 2013 (Target: -3.0%)
Cycle-adjusted Cyclical deterioration
Discretionary measures Structural deterioration Total
The Spanish Economy and The European Crisis. June 2012
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General government: measures taken in 2012 (pp of GDP) Source: BBVA Research
Fiscal de!icit: the challenge for 2012
Measures taken so far amount 4,7 pp of GDP
Central government announced measures equivalent to half of the adjustment
Privatizations, one-offs in 2011 and additional measures could help reach this year’s target
Billions % GDPDeficit 2011 (a) -‐91,4 -‐8,9Target 2012 (b) -‐57,1 -‐5,3
Difference (c=b-‐a) 34,3 3,6Additional adjustment (d) 20,7 1,9Total adjustment (c+d) 55,0 5,1Measures already takenCentral Gov.: 2012 Budget 25,7 2,4Local Gov.: real estate tax 0,9 0,1Social seg.: Tax evasion reduction 1,9 0,2Local Gov..: overlaps and unowend powers 0,1 0,0Regional Gov.: Reestructuring programs 2012-‐2014 18,3 1,7Local Gov.: Reestructuring programs 3,1 0,3Central Gov.: expenditures cuts 0 ,3 0,0
Total medidas 50 ,3 4,7
Nominal GDP 1.074,7
The Spanish Economy and The European Crisis. June 2012
Page 18
Significant reduction of the structural component
If 2013 target is achieved, structural deficit close to 0%.
A slow and steady fiscal consolidation needed
Fiscal de!icit: the challenge for 2012 and 2013
General government: budget balance and output gap (pp of GDP) Source: BBVA Research based on MINHAP
92
93 94 95
96
97 98
99 00 01 02 03 04
05
06 07
08
09
10 11
12
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
-6% -4% -2% 0% 2% 4% 6%
Budg
et b
alan
ce (%
GD
P)
Output gap
13 14
The Spanish Economy and The European Crisis. June 2012
Page 19
The new Fiscal Stability Law
EU27: fiscal rules index (2010) Source: BBVA Research based on the European Commission
Spain has bee one of the first countries implementing the new Stability Treaty
Structural target and better monitoring of regional governments
The new law improve further the fiscal rules index
-1,5
-1,0
-0,5
0,0
0,5
1,0
1,5
2,0
2,5
UK
D
K
BG
LT
SE
NL
ES
PL
EE
FR
LU
DE
AT
SI
FI
SK
CZ
HU
BE
LV
PT
R
O
IT
IE
CY EL
M
T
UE27
The Spanish Economy and The European Crisis. June 2012
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20
40
60
80
100
120
140
160
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3 Q4
Q1
Q2
Q3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
General Government debt (% of GDP) source: NS
Spain&
Portugal&
Greece&
Italy&
Ireland&
France&Germany&
Public debt as percentage of GDP Source: BBVA Research based on Eurostat and CBO
Public debt low but increasing due to high de!icits
Public debt remains at levels well below the European average even for non-EDP debt
Fiscal consolidation earlier than in most of countries but deviating from target in 2011
New Stability Law and new measures to reduce the deficit in 2012
Fiscal consolidation needed
The Spanish Economy and The European Crisis. June 2012
Page 21
Household debt deleveraging slowly
Spanish households debt similar to US levels. Slower deleveraging (higher property ratio)
Households increased savings rates and their holdings of financial assets during the crisis
A 40% fall in house prices would put wealth position (% GDP) at similar levels as in other
developed economies.
Improvement of household’s balance sheet
0
20
40
60
80
100
120
140
Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
Q4 Q1
Q2
Q3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Household debt (% of GDP) source: NS and Haver
Portugal)
Greece)
Italy)
Ireland)
France)Germany)
Spain)USA)
Households debt (% of GDP) Source: BBVA Research based on Eurostat
The Spanish Economy and The European Crisis. June 2012
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40
80
120
160
200
240
280
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3 Q4
Q1
Q2 Q3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Corporate debt (% of GDP)
Portugal)
Greece)
Italy)
Ireland)
France)
Germany)
Spain)
USA)
Large differences across countries
Spanish duality: corporate debt concentrated in construction and real estate
Deleveraging will continue in sectors and firms with large levels of debt
Corporate Debt
Corporate debt deleveraging: duality across sectors
Corporate debt (% of GDP) Source: BBVA Research
The Spanish Economy and The European Crisis. June 2012
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20
30
40
50
60
70
80
90
100
110
Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
Q4 Q1
Q2 Q3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Corporate credit (% of GDP)
Portugal)
Italy)Ireland)
France)
Germany)
Spain)
Greece)Spain)(nc))
Again large differences across countries
Spanish duality: corporate credit in sectors others than construction similar to France
Selective default of firms in high leveraged sectors (as in Ireland?)
Corporate credit
Corporate debt deleveraging: duality across sectors
Corporate credit (% of GDP) Source: BBVA Research
The Spanish Economy and The European Crisis. June 2012
Page 24
Spain: Real prices in the housing sector (1Q2002=100) Source: BBVA Research based on INE
Real estate market adjusting to levels before the boom
Oversupply of unsold homes is around 700K, below 3 years of potential demand
Real prices still have room to go down (12% more), but it is a very heterogeneous market
Open question: an overshooting of prices?
0
20
40
60
80
100
120
140
160
180
1972
1973
1974
1975
1977
1978
1979
1980
1982
1983
1984
1985
1987
1988
1989
1990
1992
1993
1994
1995
1997
1998
1999
2000
2002
2003
2004
2005
2007
2008
2009
2010
2012
2013
2014
2015
30 %
20 %
44%
The Spanish Economy and The European Crisis. June 2012
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29% 29% 29%
18% 18% 18%
14% 14%
7%
30%
17%
27%
10% 10%
0%
10%
20%
30%
40%
50%
60%
Problemático, dic-11
Problemático, feb-12
Problemático, m
ay-12
No problem
ático, dic-11
No problem
ático, feb-12
No problem
ático,m
ay-12
Total, dic-11
Total, feb-12
Total, may-12
Current coverage Additional provisions Capital add-on
Exposure €184bn Exposure €123bn Exposure €307n
The banking system reform Coverage of problematic and non-problematic real estate portfolio
The Spanish Economy and The European Crisis. June 2012
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The banking system reform
May 21 June 11
Stress test (top/down) of the Spanish banking
system.
Deadline to present plans for
new provisions (RDL May-12)
June 21
OW + RB Results (62 bn)
July 31 Before May 31
Four auditing firms appointed
to contrast estimation
procedures and impairment annotations across the
banking system
BdE/MEC press release
The “outcome will be known”
-> capital needs
The Spanish Economy and The European Crisis. June 2012
Page 27
The banking system reform
Positive aspects
The independent valuation of portfolios could give credibility to the process
The coverage of the real estate portfolio, where the bulk of the problems lie, is reinforced
The transfer of repossessed assets to ‘bad banks’ could be positive for institutions in a
worse situation, if they find investors
Negative aspects
The loss of credibility, after several definitive reforms
High uncertainty over coming months, doubts on portfolios valuation, no roadmap for creation
of ‘bad banks’, di"iculties to find investors ….
Real estate provisions are too severe for good banks with non-problematic assets
Spain needs to import credibility and regain its own
Non discrimination and no clear road map for non viable entities
The Spanish Economy and The European Crisis. June 2012
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Three Achilles' heels: 1. High funding needs
Spain: Balance of payments and capital flows Source: BBVA Research and Bank of Spain.
-25
-20
-15
-10
-5
0
5
10
15
20
25
2000
MAR
2000
SEP
2001
MAR
2001
SEP
2002
MAR
2002
SEP
2003
MAR
2003
SEP
2004
MAR
2004
SEP
2005
MAR
2005
SEP
2006
MAR
2006
SEP
2007
MAR
2007
SEP
2008
MAR
2008
SEP
2009
MAR
2009
SEP
2010
MAR
2010
SEP
2011
MAR
2011
SEP
2012
MAR
FDI inflow s Rest Eurosystem Current Account
The strong adjustment on the Spanish net borrowing will continue in 2012, but …
… at the same time, maturities are still very large in 2012
Self-fulfilling prophecy: if financial markets close the situation would be unsustainable
It’s liquidity, not solvency
The Spanish Economy and The European Crisis. June 2012
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Current account balance. As percentage of GDP Source: BBVA Research and IMF
-‐16
-‐14
-‐12
-‐10
-‐8
-‐6
-‐4
-‐2
0
2
Average1999-‐2007
2008 2009 2010 2011 2012(f) 2013(f)
Spain Greece Portugal EMU
Three Achilles' heels: 1. High funding needs
Strong adjustment in latest years despite the deficit in energy account
Imbalances explained mainly by growth differentials and high investment, rather than
loss of competitiveness
Spanish share on world exports has remained relatively constant (vs. 30% drops in US or UK)
Firm size duality: large firms are as productive as in US, France or Germany
The Spanish Economy and The European Crisis. June 2012
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Substantial, well-targeted & integral reform
If the reform is well implemented and explained to both firm owners and workers some of the expected job destruction in 2012 could be avoided
Three Achilles' heels: 2. High unemployment rate
Unemployment rates Source: BBVA Research, Haver Substantial increase of internal flexibility (hours
and wages)
Firm-level agreements are prioritized and opt-out processes are facilitated
Slight reduction of the severance payment gap between temporal and permanent employees
Legal uncertainty is removed, also for old contracts -> internal devaluation
Young workers’ learning and training promoted
The Spanish Economy and The European Crisis. June 2012
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Three Achilles' heels: 2. High unemployment rate
GDP: short-run effect 0.2% and long-run effect 4.5%
Employment: short run 4.4% and long run 10%. Lower effects for full-time employment
Real wages: short run -0.1% and long run 1%. Greater effects for labor income
DSGE results of a full implementation of the labor market reform
Spain: response to labour market reform (% deviation from trend) Source: BBVA Research
-2
0
2
4
6
8
10
12
14
16
18
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
GDP Employment
The Spanish Economy and The European Crisis. June 2012
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Three Achilles' heels: 2. High unemployment rate
The challenge: from adjustment to growth Spain: economic growth and breakdown of difference in number of hours worked (cumulative change 2007#09, %) Source: BBVA Research based on INE and EC data Short-term goal: prevent further job losses →
adjust working hours + wage flexibility and effective organisation
Estimulate growth where is scant and take advantage where it prospers
Reallocation of productive factors to firms and more dynamic sectors (foreign sector)
Eliminate internal growth barriers through a more favorable regulatory environment
GDP (-4%)
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
Employment Average working day in the year Total hours GDP
Germany Spain
GDP (-3%)
The Spanish Economy and The European Crisis. June 2012
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Labor market
Fiscal consolidation
Financial system
Competitiveness
Energy dependency
Education and R&D
Three Achilles' heels: 3. The quest for growth
Implemented a preliminary version and waiting for the final version after parliamentary approval
Credible ex ante multiyear measures. Avoid self-defeating austerity Commercial debt of local and regional governments (2.5% of GDP)
covered by CG -> fiscal stimulus close to 0,75% of GDP
Put an end to financial markets doubts about the solvency of the banking system to reduce financial costs
Next in line. Improve regulation, increase competition and reduce administrative costs. Fiscal devaluation?
Reduce energy dependency, green taxes, better regulation, explore all options
Most important challenge in the long run. A pact to reduce high school drop-out rates, and to improve vocational training -> R+D
The Spanish Economy and The European Crisis. June 2012
Page 34
Structural capacity in developed economies Source: IMF and BBVA Research
Liberal Market Economies Coordinated Market Economies Mixed market Economies
Avge. Medium Term UK USA IRL GER FRA NLD BEL AUT FIN DEN SWE JAP SPA ITA POR GRE Labour market 1 1 1 2 3 2 2 2 1 1 2 1 1 3 3 3 1.9 Corporate regulations 1 1 1 2 2 1 3 2 2 1 1 2 3 2 2 3 1.8 TIC regulations 1 1 3 1 2 1 1 1 2 1 1 2 1 2 2 3 1.6 Retail regulations 1 1 1 1 2 1 3 3 2 2 1 1 2 2 2 3 1.8 Professional services reg. 1 1 1 3 2 1 2 2 1 1 1 1 2 3 2 3 1.7
Long term Institutions and contracts 1 2 2 1 2 1 2 1 1 1 2 2 2 3 3 3 1.8 Human capital 2 2 1 2 2 1 1 2 1 1 1 1 3 3 3 3 1.8 Infraestructure 1 1 3 1 1 1 2 2 2 1 1 1 1 3 2 3 1.6 Innovation 1 1 2 1 1 1 1 2 2 1 1 1 3 2 3 3 1.6
Average 1.1 1.3 1.7 1.6 1.9 1.1 1.9 1.9 1.6 1.1 1.2 1.3 2 2.6 2.4 3.0 1.7
Annex Three Achilles' heels: 3. The quest for growth
After the labor market reform, the next objective in the short run should be to improve regulations -> structural capacity at 1.5, that is, better than core EMU countries
The Spanish Economy and The European Crisis. June 2012
Page 35
Conclusions • 2012: another year characterized by risks and challenges, with Europe and Spain falling
behind rest of the world on growth.
• The new Stability Pact and the ECB's liquidity measures are positive steps forward but are not enough: a more credible firewall needed.
• The Spanish economy is adjusting quickly. Substantial reforms, as the recent labor market reform, needed to stimulate growth and reduce the unemployment rate.
• Solvency problems are !irm speci!ic (real estate sector and few banks) and manageable.
• Public sector debt is not a problem if regional governments de!icits are curbed.
• It is all about liquidity: high dependence on !inancial markets and risks of self-ful!illing prophecies.
• Create a virtuous circle (reduction of imbalances and reforms) to restore credibility and reduce uncertainty: crucial for positive effects of economic policy measures.
The Spanish Economy and The European Crisis
Rafael Doménech
CFA Spain Academy for Financial Journalists June 27, 2012