Round trip

Debt markets mistake Spain for Italy

Until recently, Spain was being compared by debt investors with safe, stable Germany. Now, its foggy regional and national politics mean investors want a premium over debt from indebted, sclerotic Italy. The confusion is likely to be temporary.

Despite Spain's high jobless rate and primary deficit, the country's debt was for months seen as more desirable than Italy's. The centre-right government of Mariano Rajoy moved more quickly to reform during the sovereign debt crisis, which helped fuel confidence. Yet its 10-year debt has underperformed Italy's since January, and now trades with a 20-basis point premium. That may reflect Spain's heavy debt issuance this year, but it is also due to fears of the political upheaval that have typically tarnished Italian debt.

Spain has two important elections coming up. One is Catalonia. Regional elections in September are being treated as a plebiscite on independence by secessionist parties. Spain then faces a general election in December. Polls show neither of the two main parties will gain an absolute majority, so a coalition government with upstarts like radical Podemos or more moderate Ciudadanos looks likely.

For debt investors, there are various outcomes. A Podemos-backed coalition raises the risk of a reversal of recent reforms. But a government formed by a mainstream party supported by Ciudadanos, which embraces market reforms, would be more benign. What's more, the lesson from Greece's recent travails is that there is limited room for radical policies. As for Catalonia, unilateral independence would be illegal and risky, and require leaving the European Union.

In Italy, the political situation is starting to look binary too. Prime Minister Matteo Renzi is struggling to force reforms through the country's Senate to streamline government. If he succeeds, Italy will be more stable than it has been for decades. If he fails, chaotic elections will follow.

A brave investor could buy Spanish debt and sell Italy. While politics are blurry, the economic outlook is relatively clear. The International Monetary Fund expects Spain's GDP to grow 3.1 per cent this year and 2.5 per cent the next. For Italy, it expects 0.7 per cent and 1.2 per cent. Based on that distinction, the premium is unlikely to last.