Capital Flees Spain As Budget Gap Jumps

MADRID (Reuters) - Capital flight from Spain gathered pace in May and the central government deficit rose further above target in June, taking the country two steps closer to the full-scale bailout it is desperate to avoid.

Outflows rose to 41.3 billion euros ($50.6 billion) as the government's rescue of one its biggest banks hit already fragile investor confidence and triggered a plea for European aid worth up to 100 billion euros for the country's lenders.

In all, 163 billion euros - or around 16 percent of economic output - left Spain between January and May, with domestic banks sending money abroad, foreign lenders pulling out cash and mostly non-resident investors dumping domestic assets.

Over the last 11 months, funds equivalent to 26 percent of GDP exited the country, Tuesday's data from the Bank of Spain showed.

Spain's struggling economy, which is expected to remain in recession well into next year, is at the centre of the euro zone debt crisis, and rising refinancing costs risk shutting the country out of international debt markets.

Domestic demand has stalled since the crisis started four years ago, hitting a service sector that accounts for around 70 percent of the economy, while sky-high unemployment rates have further eroded consumer confidence.

Retail sales fell by 5.2 percent year-on-year on a calendar-adjusted basis in June, separate data showed on Tuesday, marking a 24th straight month of declines.

"These figures are proof that the Spanish economy continues in recession and a drop in retail sales could indicate a GDP contraction of around 2 percent this year," economist at Madrid broker M&G Valores Nicolas Lopez said.

"For the moment there's no sign this is going to change in the medium term."

SQUARING THE CIRCLE

With tax revenues falling sharply as the recession deepens, Spain reported a deficit of 4 percent of GDP on its central government accounts in the first half of the year, above a goal of 3.5 percent set for the whole of 2012.

That target could be eased as Spain decides later in the year how to use an extra 1 percent cushion granted by the European Union in July when the country's deficit target was widened to 6.3 percent for 2012 from 5.3 percent initially.

The government announced a new 65-billion-euro austerity package in July, two months after stepping in to prop up major lender Bankia .

In June, it requested help from Europe to recapitalize its banks, battered by the collapse of a decade-long real estate bubble in 2008.

But the initiatives failed to calm investors for more than a few days, and Tuesday's gloomy numbers will do nothing to ease pressure on the bond yields that Spain needs keep from rising to avert a full-fledged bailout.

The premium investors pay to buy Spanish over German debt was around 532 basis points on Tuesday, far below last week's euro-era highs on hopes the European Central Bank will announce stimulus measures, helping to bring Spanish and Italian borrowing costs down.

Tuesday's data showed Spanish and non-domestic banks moved 31.9 billion euros out of the country in May. The headline figure compared with total outflows of 26.6 billion euros in April and a peak of 66 billion euros in March.

Plummeting domestic demand was reflected in May current account numbers also published on Tuesday by the central bank and showing a deficit of 754 million euros, narrowing sharply from 3.4 billion euros in the same month of 2011.

The gap shrank on a lower trade deficit and a lower primary income deficit - the difference between money paid abroad and money received.

The trade gap stood at 1.5 billion euros, down from 3 billion euros a year earlier, as exports rose 5.5 percent while imports dropped 2.1 percent.

The government, which expects the economy to shrink 1.5 percent this year and 0.5 percent in 2013, has passed some of the deepest budget cuts in decades to deflate one of the euro zone's largest budget deficits. The gap stood at 8.9 percent in 2011.

The tax hikes also passed under the austerity program, including a 3 point rise in value-added tax, are expected to further dent high street spending.

"(Spain) needs more time to rebalance the economy and hit the deficit targets. The current framework is making Spain dig itself into a slightly bigger hole," Guillaume Menuet, economist at Citi in London, said.

(Additional reporting by Jesus Aguado and Manuel Ruiz; Editing by Julien Toyer, John Stonestreet)

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