Spain’s Halfway Between the Bailout Club and a Better Address

(Bloomberg) -- Spain is trying to break away from being associated with the club of nations that needed a bailout during Europe's debt crisis. Markets may be buying it – but there's a way to go. 

An early clean-up of its banks and a series of unpopular reforms aimed at boosting competitiveness mean there's a lot more investor love for Spain. Over the past year, Spanish government bonds have outperformed those of Italy and Portugal – and among the periphery nations excluding Ireland, Spain has the lowest yield spread and best fundamentals, according to ABN Amro.

“Compared to the rest of the periphery, Spain is in a much better shape,” said Kim Liu, a strategist at ABN Amro in Amsterdam. “Although there can always be noise out of the political arena, we think they have been pushed back and the focus should turn on structural improvements, the big budget deficit still poses a risk to the generally positive fundamentals underpinned by strong growth.”

A re-balancing of the economy away from a credit-fueled construction bubble into a thriving exports sector coupled with a sharp fall in unit labor costs place Spain's economic structure closer to that of Ireland than to its traditional peer Italy. Growth in Spain has averaged 2.6 percent since 2014, when it exited the crisis, outperforming its main euro peers except for Ireland.

Still, that may not be enough to seal the deal at a time of political risk.

While Spain dissipated market concerns after Prime Minister Mariano Rajoy was able to form a center-right minority government after two inconclusive elections, the country isn't exempt from uncertainties stemming from the new Trump administration, Brexit negotiations and a crucial political year in Europe with elections in three core member states including France and Germany.

In a situation of stress, Spanish government bonds are still moving closer in line with the periphery than the semi-core, reflecting investor doubts over its capacity to weather market jitters and exposing some its remaining structural weakness, highlighted by high unemployment and elevated debt.

Spain's debt pile has more than tripled since 2007 after a decade-long housing bubble came under an abrupt end. Perhaps more worryingly is the nation's inability to rein in its public deficit in a context of strong economic growth and ultra accommodative monetary policy from the European Central Bank.

--With assistance from David Goodman.

To contact the author of this story: Maria Tadeo in Madrid at mtadeo@bloomberg.net.

To contact the editor responsible for this story: Jeff Black at jblack25@bloomberg.net, Zoe Schneeweiss