GREECE ISN´T THE EUROZONE´S ONLY POLITICAL HEADACHE / THE WALL STREET JOURNAL

Heard on the Street

Greece Isn’t the Eurozone’s Only Political Headache

Greece and Europe have reached agreement, but political risk hasn’t gone away. Spain may yet pose headaches for investors

By Richard Barley

Feb. 24, 2015 10:10 a.m. ET

 Demonstrators gather at in Madrid at a march organized by the left-wing party Podemos on January 31. The antiausterity party has risen to prominence over recent months and is vying for pole position ahead of this year’s elections. Photo: Agence France-Presse/Getty Images


What has happened in Greece has, for once, stayed in Greece—or has it?

Broadly speaking, there has been no contagion to European bond markets from Greece’s tussle with the eurozone. For most investors, Greece should fade from focus, at least for a while, now a preliminary deal has been struck to extend its bailout. But other sources of political risk remain. Spain could pose challenges, while Italy might offer opportunity.
 Last year, both Spanish and Italian bonds performed spectacularly. Spain had the edge, returning 16.7% versus 15.1% for Italy, according to Barclays indexes. By late October, 10-year Spanish yields were 0.4 percentage points lower than comparable Italian yields, as Madrid’s economic reforms and better growth contrasted with continued stagnation from Rome.

But this year Spain has fallen behind. Italian bonds have returned 3.2%, well ahead of 1.8% for Spanish debt. The gap between the two country’s 10-year yields has narrowed to less than 0.1 percentage point. The trend could have further to go.

That might seem surprising. While Spain has returned to growth, Italy’s economic performance is woeful: it has failed to record a positive quarter of growth since 2011. Debt in the third quarter of 2014 stood at 132% of gross domestic product, according to Eurostat. The low rate of nominal growth in Italy means the country still hasn’t stabilized that ratio even with historically low interest rates.

But concerns about that are being suppressed by the European Central Bank’s plans to purchase sovereign bonds. Both Spain and Italy will benefit. But what the ECB’s policies cannot deal with, in the same way they cannot improve a borrower’s innate creditworthiness, is political risk.

Spain faces both regional and national challenges this year. The question of Catalan independence continues to rumble on. In a symbolic vote last November in Catalonia, around 80% of voters favored secession, although turnout was low. In January, Catalan President Artur Mas called for September elections that will ensure the focus remains on the independence question.

At a national level, left-wing party Podemos has risen in startling fashion to vie for pole position with the governing Popular Party. It has talked of debt restructuring, massive monetary expansion, tax increases and targeted nationalizations of key industries. Parliamentary elections aren’t due to be held until the end of the year in Spain. But the rise of Podemos in itself will influence the stance of other political parties.

Meanwhile, Italian Prime Minister Matteo Renzi has started to make progress on reforms, including on labor markets and the banking system. The Organization for Economic Cooperation and Development says that if fully implemented, the reforms under way could increase GDP by 6% over 10 years.

The question of whether to favor Italy or Spain might matter more than last year. The low level of yields means returns will be harder to come by. Politics in Greece have already stolen the limelight. They could yet do the same in Spain.