Financial Crisis in Spanish Regions Pressures Central Government

A major Spanish region, akin to a U.S. state, has been declared “totally bankrupt” by the incoming administration. Spokesmen for the People’s Party in the Castilla-La Mancha region accused the previous socialist government of destroying unpaid bills totaling 2 billion euros.

While Spain’s socialist government denies the charge, the new People’s Party administration in Catalonia found that Spain’s second-largest region had twice the level of debt expected before assuming office. The ensuing budget chaos has prompted Moody’s to warn investors Monday that Spain’s central government will find it “very difficult” to meet its deficit reduction target for 2011.

“It’s just not a good time to point out the potential risks that would emanate from local governments having problems in Spain,” commented Vincent Truglia (left), managing director of global economic research for Granite Springs Asset Management, and former head of Moody’s sovereign risk unit.

“It just points out how the economic downturn is affecting local governments too,” Truglia told AdvisorOne in a phone interview. While Truglia dismissed Spanish politicians’ bankruptcy rhetoric, he cautioned the real onus of Spain’s financial woes falls on everyone who owns its sovereign debt. “Governments don’t go out of business,” he said. “Investors are going to have to pay for that [eventual] haircut.”

According to Moody’s, deficits in Catalonia and other provinces reveal the central government’s inability to impose fiscal discipline. By presenting a budget whose deficit amounts to more than twice Madrid’s target, Catalonian bloat suggests Spain lacks “effective tools to enforce fiscal compliance at the regional government level.” The dire finances of Spain’s ailing regional economies casts in doubt the ability of Spain to reduce its deficit from 9.24% of GDP this year to its 2011 target of 6%.