Spain’s total foreign debt declines to its lowest level since the crisis broke

Spain’s external debt as of the end of September stood at 1.66 trillion euros, the lowest level since the middle of 2008, largely as a result of deleveraging by the banks, according to figures released recently by the Bank of Spain.

The foreign debt of companies and households, banks, the public administrations and the Bank of Spain — which stood at 1.77 trillion euros at the end of June 2012, almost triple the amount of a decade ago — declined by 47.397 billion from June 2013. As a percentage of GDP, at the end of September it stood at 163 percent, compared with 171 percent 18 months previously.

The level of indebtedness with foreign banks and investors, sovereign funds and, more recently, the European Central Bank as a result of the liquidity crunch is the counterpart of the massive cheap overseas funding previously made available to Spain that fueled a huge real estate and consumer bubble that burst at the end of 2008. At the time, Spain was racking up current account deficits of around 10 percent of GDP, second in absolute terms only to the United States.

When the crisis broke, Spain’s foreign indebtedness became a major concern for the financial markets because of the speed at which it had been built up and the poor prospects for economic growth.

One of the main rationales behind the austerity drive of the past three years was to correct these imbalances. As a result, Spain is expected to end this year with its first current account surplus since the euro was introduced and with total external debt at its lowest level since the crisis broke.

While strong export growth and weak imports due to the sharp fall in domestic demand have helped rectify the external imbalances, the main reason behind the reduction in external debt has been deleveraging by the banks with the consequent negative impact on levels of lending to companies and households.

The financial sector accounts for about half of all foreign debts, excluding foreign direct investment, and the external debt of the banks has fallen by 60.8 billion euros since September 2012, while the amount borrowed from the ECB has also declined by 131 billion euros.

This is a result of the restructuring imposed on the sector as part of the 41-billion-euro package Spain received from its European partners to clean up the banking system and new solvency requirements. Despite warnings by the IMF and the European Commission, the banks have opted to cut back on lending as one way of improving their solvency ratios to the detriment of getting credit flowing again to revive the economy.

The fall in the banks’ external indebtedness has comfortably offset the increase in public debt as a result of successive deficits. Household and corporate overseas debt has also increased slightly as foreign lenders fill the gap left by domestic banks.

While the banks are expected to continue to deleverage, the situation of net external debt is more complex. The amount owed to overseas lenders minus the value of assets held overseas almost hit a trillion euros by the end of September 2013, the biggest gap in the current historical series. However, the increase was in part due to two positive reasons: an increase of 50 billion euros in foreign direct investment, and an increase in the value of securities held by foreign investors as a result of the pick-up in the stock market.