For some time now it has been inevitable that Portugal would be obliged to seek a bailout of some form. One of the clearer recent signals was the government's issue of 6-month and 12-month paper with yields in excess of 5%, more than the US Treasury has to pay on 30-year paper. Even before the financial crisis, GDP growth in Portugal was relatively anaemic, but in these tough economic times, the country faces real problems.

Portugal is similar to Ireland in that bulk of the country's debt is held by the private sector. In seeking to alleviate the private sector's woes, the public sector has taken on much of that debt and now shoulders a burden of its own. Spain's private sector also holds the lion's share of the country's debt and we find this particularly worrying. Portugal, Greece and Ireland, all of which have now sought bail-outs, make up a relatively small percentage of eurozone GDP, but if the situation in Spain were to deteriorate, in our view this would represent a tipping point. The market certainly sees it this way. There has been a relief rally following Portugal's announcement, and this is likely to carry bullish sentiment in the financial markets some way, but Spain's shadow will remain.

Spain entered the financial crisis with relatively healthy government debt figures but the economic pressures of the last few years have seen those numbers climb while GDP has shrunk. The regional banking system is in very poor condition, suffering heavy losses from loans made during the good times many of which are which are now non-performing. Added to this is the fact that the country as a whole suffers from high unemployment, particularly among its youth.

However, whereas Greece and Ireland's debt to GDP ratios are well into triple digits, and Portugal's are not far behind, Spain's debt to GDP ratio at the end of 2010 was approximately 64% . This would certainly point to the country's debt levels being more manageable, but debate nonetheless rages as to how much it will cost to recapitalise the banking system. Investment banks seem to think somewhere in the region of ?50bn plus while the Spanish government maintains that the figure is much lower. It is important to bear in mind that, along with a number of other European countries, Spain has previously benefited from extremely generous social policies so there has been and still is good scope for cutting public expenditure. Spain of late has been doing the right things and this is reflected in the markets. For example, in November 2010, Spain was paying around 2.8% more than Germany on its 10 year government bonds, whereas now, that figure is more like 1.8% .

Our main concern is that, ultimately, the only way to shake off such a large debt burden is to grow your way out of it and we struggle to see how Spain will do this. Another factor worth bearing in mind is that Spain has to issue around ?200bn  of debt this year, and if auctions occur during a period in which market sentiment is depressed, it may struggle to raise the funds. For now, Spain is managing its position well, but it must continue to be seen to make progress in order to avoid going the same way as its neighbour.

NOTE

Jupiter Asset Management Limited (JAM) is authorised and regulated by the Financial Services Authority and its registered address is 1 Grosvenor Place London SW1X 7JJ. JAM is a subsidiary of Jupiter Investment Management Group Limited and the group is collectively known as "Jupiter". The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.