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Spain’s Deteriorating Economy: How and Why?



Spain is a land of history, football, beauty, architecture, bull fighting and so much more. Recently it has added another adjective to the list; economically destabilized country. Since 2008, Spain has started experiencing a majorly nose diving economy. First Greece, then Ireland, then Portugal and now is Spain’s turn to experience a rapidly crashing financial situation. The government is in tatters over what to do and how to handle it all. Before analyzing the reasons for this major down turn in one of Europe’s most important economy, let us revise the background of the country’s economical progress over the years to better understand how it reached where it is today.

In order to join the EU, Spain worked hard on improving its financial status. The Maastricht treaty demands a certain criteria for interest rates, inflation rates, GDP and government deficits. Spain picked up its budget deficit from 6.5% of GDP in the 1990s to introduce soaring budget surpluses in the country by 2005. From 1990 to 2007 Spain generated about one-third of Eurozone’s employments. This was a landmark achievement. The Maastricht treaty also called for Spain to lower its interest rates on property hence providing another grand opportunity for real estate investors to make huge investments in the country. Labor demands hit new heights. Many more investors started investing in construction and land deals as they could afford bank loans on lower interest rates. Immigration rates increased hence increasing housing demand. The economy started making progress by leaps and bounds.

So what brought Spain’s flourishing economy crashing down? The Spanish economy is highly dependant on real estate. As construction market flourished under low interest rates and high investments, more and more houses were created. As the demand for housing fell down towards the end of 2007, so did the market. This created a lot of unemployment. The generous unemployment benefits drained Spain’s economy, crippling it within a few years. As unemployment increased, Spain’s budget fell from 2% of GDP surplus to 4% of GDP deficit.

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The crashing construction market affected Spain’s banks. When two of Spain’s leading banks Santander and BBVA pulled out of the lending business, the Cajas system of banking continued to lend heavily into the market. By 2009, Cajas owned 56% of the mortgages in Spain. As a policy, the collateral, repayment history, loan-to-loan ratios and other investment information was not disclosed by the cajas system and the lending went relatively unchecked.

When the construction market crashed, so did the cajas system. Constructions companies owned billions of dollars to the banks. According to an estimate the banking system faced a €180.8 billion deficit. This was three times more than what banks could handle. The entire system went into bankruptcy; eventually causing investor confidence in Spain’s banking system to fall.

As the financial turmoil gets uncontrollable, the government is introducing austerity measures and bail outs to help pull the economy back on its feet. There are three options for Spain at the moment:

  1. Spain pulls out of the Eurozone
  2. Spain fights it off
  3. Create a common currency alongside the Euro.

The future of Spain’s hard hit economy remains unclear. How the government will cope with the public outburst and heavy debts, only time will tell.



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