Blog Post

Subordination is not the main issue in Spain

Many commentators have recently argued that sub-ordination of Spanish debt to the official assistance is the main driver of Spanish bond yield increases. Default on Spanish debt supposedly is becoming more likely because the new debt coming from the ESM is senior to the old debt. In this column, I argue that this is not […]

By: Date: June 18, 2012 Topic: Macroeconomic policy

Many commentators have recently argued that sub-ordination of Spanish debt to the official assistance is the main driver of Spanish bond yield increases. Default on Spanish debt supposedly is becoming more likely because the new debt coming from the ESM is senior to the old debt. In this column, I argue that this is not the case. The main driver of the yield increase is the increase in the absolute debt level due to the assumption of private sector debt by the government.

The new programme is Spain has two outstanding features for the question at hand. First, it increases Spanish debt by around 10% of GDP. Second, this 10% of debt is treated senior to the 70% of exisiting Spanish debt. To illustrate what is driving the increase in yields, let’s do some simple arithmetics. Suppose that Spanish debt has a face value of 100 but a market value of 70. This means, markets expect that only 70 of the 100 will be repaid. The ability to pay of the Spanish government thus amounts to 70.

With the new programme, debt is increased by around 14%. If the ability to repay stays constant and the programme is providing finance without subordination, then the value of the outstanding debt should fall from 70 cents on the euro to 61 cents on the euro. If the 14 units of additional debt are given a senior status and we assume that the Spanish government will repay them in full, the capacity to service the old outstanding debt will be reduced by 14 and will amount to 56. This implies that market price of debt will fall to 56. The table illustrates the simple numbers.

Before programme

After programme without subordination

After programme with subordination

Face value of debt

100

114

114

Ability to repay debt

70

70

70-14

Ratio market over face value

0,7

 

0,61

0,56

Subordination thus indeed lowers the market price of outstanding debt. However, this effect amounts to around 1/3 of the problem while the fact that new debt is put on top of old debt drives 2/3s of the yield increase. The seniority effect is thus of second order compared to the actual increase in debt.

The key for Spanish solvency is thus not that assistance is given seniority or not. The key question is whether banking sector assistance as such will mean an increase in Spanish net debt. To the extent that private creditors of banks shoulder the largest part of the burden, the equity injections into the Spanish banking system should not negatively affect Spanish government solvency. In fact, becoming a shareholder of banks that have been restructured at the expense of old creditors of banks should not imply a net financial liability. On top of this, a significantly lower interest rate on the programme debt will contribute to debt sustainability. Moreover, sorting out banking sector problems should increase the ability to repay debt as credit provisioning to the dynamic export sector gets improved. On the downside, imposing losses on private creditors of banks may dampen consumption as well as investment depending on who are the main creditors to banks. It is therefore of central importance that the public authorities investigate carefully who are the creditors of banks and how losses would affect their behaviour. Overall, imposing losses on private creditors of banks will be a possible way of improving solvency of the Spanish government.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Filippo di Mauro, Wolfhard Kaus, Steffen Müller, Gianluca Santoni, Verena Plümpe, Andrea Roventini, Valerie Smeets, Nicola Viegi, Markus Zimmermann and Javier Miranda Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts