Spain’s funding chief: ‘Covid was like the proverbial alien invasion’


Pablo de Ramón-Laca is director general of the treasury and financial policy at Spain’s Ministry of Economic Affairs and Digital Transformation. That places him in charge of the world’s ninth largest sovereign debt stock, according to S&P data, for a country pummelled by the Covid-19 pandemic. Spain has the second highest number of cases in the EU and the seventh highest in the world. But even that is not the full story of the pandemic’s impact.

Spain may have worked hard to put the horror of its property bubble a decade ago behind it, but some of the industries it is best known for have been among the hardest hit by the pandemic. It is the world’s second most visited country after France, making tourism a vital part of its economy. Global lockdowns and travel restrictions had an instant, brutal impact. Spain is also a big manufacturer of cars — another industry that has suffered.

But the EU was much quicker to step in and support its member states in this crisis than in previous ones. That helped Spain maintain access to capital markets and fund itself at ever decreasing interest rates as it looks to invest its way out of the crisis, including some spectacular syndicated bond issues.

De Ramón-Laca, who runs that funding programme, spoke to GlobalCapital’s editor, Ralph Sinclair, on Wednesday about navigating the route to recovery, getting deals done in extraordinary markets and its debt issuance to come.

GlobalCapital: One of the memes of the year has been ‘How it started; how it’s going’. Can you give us a how it started, how it’s going view of Spain’s funding plans? And also how it might go — how you expect those plans to change as the country recovers from the pandemic.

Pablo de Ramón-Laca, Spain:The horizon has got to be two years. The world was very different in January 2020. How it started was with Spain slowing down gradually from 3% growth to roughly 2% — significantly above our peers, reducing the deficit, stabilising. We had announced €32.5bn of net issuance.

And then March happened. When the pandemic hit us, we unleashed — I have to use that word — the power of the Treasury and issued very, very quickly. Most of the issuance last year took place in Q2 because we were diving into the abyss, and we didn’t know how deep the crisis would be, how deep the slowdown would be, or the inevitable recession that would ensue.

The health measure of putting the economy in an induced coma; that was the confinement. We had to speed everything up as quickly as possible, so we increased from €32.5bn to an expectation of €130bn.

Then we reached the summer and realised that it wasn’t a usual crisis. In Spain, what usually happens is that the unemployment soars — the young are shed from the labour force immediately, tax revenues collapse. Government spending increases very significantly. It happened to a lesser degree than was anticipated.

This time around, we furloughed the labour force, and we provided liquidity support to firms. Along with the rest of Europe, the reaction was swift and effective.

What we realised during the summer was that we had had the biggest collapse in output since the Civil War but revenues fell less than proportionately, which was a strange thing for a treasurer to see.

Also, the regions were paying back their debts with the central government early because borrowing conditions were very good. They were able to obtain cheaper funding from the banking sector and other investors. We allowed that early redemption to take place in order to help the regions with their funding.

So we realised that we had to slow down issuance throughout the second half of the year. Very quickly, we corrected to €110bn. That mean that towards Q4 of last year we did very small auctions.

We also knew that we had to accelerate again at the beginning of 2021. We don’t want to end up more indebted than is absolutely necessary, because we are very much aware that this is an extraordinary situation and at some point, we will have to reduce it gradually.

So this year, based on a new estimate of revenues adapted to the dynamics that we saw last year — and having a full year budget, unseen since 2016, helps a lot — we began with an idea of €100bn of issuance in net terms, and just under €300bn gross. So that’s how it started.

How is it going? In total we have printed €64bn, of which medium and long term issuance is €40bn and €24bn was in T-bills. We’ve done 22%, roughly, of our programme and are ahead of schedule.

We expect the programme to be gradually reduced again this year: €100bn was a very conservative estimate. It was based on very prudent assumptions.

In our budget, we have included the full €27.4bn of eligible expenditure for the NextGenEU programme, which is an ambitious amount. We included an assumption of zero early redemptions from the regions but we are already seeing some because the borrowing conditions are still good for them. We are providing financial relief to them by relieving them of those loans contracted with us a few years ago so they can replace them with new, cheaper funding.

The funding programme is always the adjustment variable. The Kingdom of Spain’s funding programme is always the one to accommodate all these alternative sources of funding — from Europe, early redemptions by the regions, and of course, positive surprises compared to our conservative estimates on tax revenue.

So far, our cost of funding for the year is minus 0.07% across short and long term debt, including the €5bn we did of 50 year funding, which is borrowing we don’t usually do.

The total cost of all our debt is still falling. Last year, it ended at 1.86% and it is now 1.83%. That is likely to continue to fall because we have tranches of bonds issued five or 10 years ago that will disappear from the portfolio, to be replaced with new bonds at longer maturities, issued at 0%. Even if rates increase, Spain’s total interest burden will continue to fall for the next couple of years.

This is the opportunity that we have over a horizon of two years: debt that is ever cheaper to maintain. If we can use that debt to grow, and to increase GDP, we can reduce the debt-to-GDP ratio much more effectively than if we reduce the deficit.

We have to spend, yes, but to invest, which is needed in Europe for the past 10 years. But that is what we’re doing now. There will inevitably be some damage and scarring to the European economy but I’m optimistic about the next few years, because we’re finally getting it right. We are investing our way out of this, and leveraging on the possibility that the capital markets offer.

S&P has Spain’s rating on negative outlook. One reason is its social security spending. You’ve said it is right to borrow and spend or invest the money you raise. But how much of a burden is social security spending on those plans, especially given the pandemic and the government support of the labour force?

Social security includes pensions, which is a long-term demographic issue for Spain. I don’t want to downplay it, it is a structural problem, but the pension system has been in deficit since 2010. Usually a country changes the dynamic to avoid the pension system going into deficit. Ours has been in deficit for 10 years. Reform is under way but it is gradual.

The new reform is gradual. But social security also now includes the furlough scheme. That injected a direct transfer to households and firms of a total of €41bn. This was part of what we funded last year, and we transferred it directly to households and firms through social security to help them through the economic induced coma.

Just for you to get an idea, it is the same amount that was injected into Spain’s banking system in 2012 through the European Stability Mechanism loan.

S&P knows this. However, the rating with S&P is higher than with other ratings agencies. They upgraded Spain at the end of 2019, so that negative outlook might lead them to converge to where others are — at A-.

We have to admire and be thankful for the fact that rating agencies were very patient last year, and were willing to see the big picture. They saw the European response, they saw that it wasn’t the same as last time. They saw that this time, there is a central bank willing and able to ensure that financial conditions are helpful.

There is a concerted European response this time round, which in 2011 was doubtful. Back then it was perceived as a moral crisis — some countries were perceived to be spending too much and lending unwisely.

This time round it is more like the proverbial alien invasion — it’s nobody’s fault and we all have to get through it. This is why it’s been easier. Political solidarity has been significant and the response was very, very quick and very big.

I think S&P will analyse the situation holistically like they did last year, they will see Spain in the context of a stronger euro and a stronger set of institutions. They will want to see the investment programme that we are offering, the way we plan to get out of this crisis and the vaccination programme.

Speaking of those European institutions, it’s hard to overplay the importance of the European Central Bank asset purchasing programmes in bringing down costs of funding. How has that — and the course of the pandemic — changed your interaction with your other investors in the market? What are they worried about nowadays?

The eurosystem has been instrumental, of course, in avoiding deflationary pressures and an unwanted tightening of monetary policy. They’ve done the job that they’ve been charged with. They have a very difficult job and they’ve done it very well.

They hold €89bn of Spain’s bonds, according to the ECB website, in the Pandemic Emergency Purchase Programme [Pepp] for Spain and €295bn in the Public Sector Purchase Programme, which adds up to about 29% of our total debt outstanding in consolidated terms.

According to the same sources, they also have €768bn of Germany’s bonds, which is about 34% of their debt, and 37% of Dutch debt. This isn’t a net transfer. This is them implementing and achieving their monetary policy objectives.

With investors, last March was a difficult proposition. The 10 year Bonos yield rose up to 1.22%. Soon after that we had an auction scheduled for March 19. The day before, the ECB announced the Pepp and the auction went very well. The following week, we did a seven year syndication, which also went extremely well.

Tensions in the sovereign debt market lasted about a week — that’s how quickly the ECB responded. They’ve learned from past experience.

The ECB absorbed our net supply last year — around €110bn. But we issued just under €300bn in gross terms.

Ensuring that the other investors retained their positions was a similar exercise to when there are no Asset Purchase Programmes. You still have to interact with them and be very transparent. You still have to show commitment to reforms, explain the macroeconomic situation, be candid about the uncertainty of the pandemic and that the exercise of forecasting is a risky one. The degrees of uncertainty are significant.

In my experience, you don’t have to show investors that you have the finished product — that we are already where we want to be. What you have to show them is that you have a credible way to get there and that you are therefore underpriced — that your country is doing better than it is being given credit for.

With Spain, that is a relatively easy thing to do. There are many myths out there about Spain and about the way we grow, but they are very easy to dispel. Not every bond is with the ECB. The 50 year, for example, can’t be touched by the ECB for another 19 years.

What sort of myths are you referring to?

That Spain is all construction, for example; that if construction doesn’t work, Spain can’t grow. Many analysts have taken a very long time to change their fundamental model of our spending. And it keeps underestimating our growth.

In the previous crisis, we adjusted construction from 12% of GDP to about 6%. We went from being an economy that over-invests in its real estate, which is clearly unsustainable, to one that exports services, which has its own dynamic. We were growing much more than we were given credit for.

It’s relatively easy to have that dialogue with investors. It’s very important to be absolutely candid with them as to what you can achieve and what the Spanish economy is likely to achieve. It’s a long term relationship with them. You can’t sell them a 10 year and then not deliver.

Do investors worry about the impact of the lack of tourism since the pandemic began, and should they?

Mobility restrictions have impacted this industry very significantly. This is one of the reasons why Spain had one of the biggest falls in GDP last year. The virus affects industries specialising in interpersonal relationships. We went from being a construction-based country to one that exports services. So we were always going to take a hit in this crisis.

But we have an undeniable comparative advantage in high value tourism, not just the cheap beach resorts. We’re very specialised, with best-in-class hotels and gastronomy. When you lift the restrictions, like we did in Q3 of last year, quarter-on-quarter growth shot up to 16.7%.

When you unleash — I use that word again — mobility for interpersonal relationships, growth recovers extremely quickly. So it’s all about the vaccines and it’s all about defeating the immediate spread of the virus. These jobs that are being lost are going to be recovered very quickly. The sun will still be there and so will our comparative advantage.

At the same time, we are investing in changing much of that model. We’re empowering the digital and ecological transition; investments in terms of renewable energy, mobility, digitalisation, spreading the fibre optic network. We are making that more powerful through an aggressive investment programme.

We will still have the comparative advantage for the services that we were exporting and we are investing in higher value added industries.

Investors worry about the pandemic having a big impact, with significant scarring. Our job is to protect those workers until the vaccinations are done, protect the firms, protect Spain’s productive capacity while this induced coma lasts, but also to invest in increasing potential growth.

One thing investors seemed to be worried about, looking at your recent syndications, was whether they would get any bonds at all. Your two syndications this year attracted orders of a magnitude that a few years ago would have been unthinkable — especially at the price you achieved. The central bank and the state of the world have a lot to do with that, but I wondered what those deals told you about the eurozone govvie market. The 10 year in particular had a volatile order book and I wondered what you learned from those two deals.

Well, syndication is a process of price discovery. It is a process of discovering how the Spanish taxpayer can best benefit from the demand available for the flow of cash payments that we are selling in a bond.

In the 10 year, for example, there were two types of investor. There were the real money guys that wanted the flow of yearly coupons and the quality of the rating. And then you have the faster money — the arbitrageurs — that are very flexible and can put in very large orders, because they’re allowed to assume that much risk. What they want is to harvest new issue premium and then sell into a very liquid market, made more so by primary dealers and the ECB.

Those two groups had two very fundamentally different ideas of fair value. So when we started at Bonos plus 8bp, both groups were in. We had feedback from the real money that they would ultimately be good at Bonos plus 4bp, so we decided to cut the middle pricing step and go straight to that level.

Everyone knew that was where I wanted to land, because I wanted to do €10bn and I had a strong enough book to do it.

The violence of the reaction from one of the groups created a lot of noise and there was a significant delay in pricing. We priced far too late, but we learn — you might know where you want to land, but it’s good to go through the motions of the dance, because it’s a negotiation. An intermediate pricing step would, in retrospect, have been better, but we would have always landed at Bonos plus 4bp.

The more than €70bn of fast money orders that dropped weren’t essential to this specific transaction. On this occasion, it was OK for them to leave.

We have to get used to the fact that the important thing is the quality of the book for the amount that we can issue, rather than the size of demand.

We have to get used to the fact that there is volatility in a price discovery process like ours. Some were expecting headlines would appear when the Kingdom of Spain “lost €70bn in a shocking price move”. Several were betting on the fact that we would cave. That didn’t happen because we saw there were €55bn of orders good at Bonos plus 4bp.

Fast money investors, in the presence of benign funding conditions, have to adapt to what the real money thinks about the product. They’re not as essential as they think they are in these conditions.

Every syndication is different and they may well turn out to have more negotiating power later on. But in this particular transaction, we made a call and it was the right one.

The 50 year point was harder to price. Interpolation is impossible because it is the longest point in our curve and extrapolation is tricky. We listened to market participants’ views on fair value and on the required new issue premium and we were able to do what we wanted to do, which was €5bn.

It doesn’t pay to be greedy because Spain does not have a base of very long term savings — hence the pension deficit. We were tapping into a non-resident investor base, with 92% of the bonds sold outside Spain, so we didn’t want to overdo it. We want to be able to tap this bond by auction later on.

I don’t think we’ll see more €15bn or €12bn transactions because we are more set in what we have to issue. Last year, we did €10bn and then €12bn in Q2 because we didn’t know how deep the hole was. It turned out it wasn’t as deep as we had anticipated, so we slowed down.

We will have smaller syndications at certain points on the curve, placed among a very high quality investor base, to maintain liquidity of our curve.

Another thing that will detract from the volume of your conventional issuance will be your green bond, which has been in the pipeline since at least 2019. Politics and the pandemic have delayed it but you have committed to a syndication in the second half of the year. How are the plans for that deal progressing?

We’re looking for a conventional green bond, like France, Italy or Ireland did. We’re not looking to do a German-style green bond.

To us, it’s not just an exercise in efficient debt management. It is also about diversifying our investor base and setting up the infrastructure for the private sector in Spain to be able to price its green bonds against the sovereign.

We have a mandate to develop a green bond programme and to show the commitment of Spanish environmental policy.

It would have been a pity to have issued a green bond based on the 2018 budget in 2020. All of those expenditures had already taken place. It would have been a green bond based on refinanced past expenditures.

It would have been possible because it’s within the ICMA Green Bond Principles to have a three year look-back period. But it wouldn’t have reflected the preferences of the new budget.

Last year, we were negotiating the new budget and then Covid happened, so it was decided to deal with that first and then concentrate on the 2021 budget.

As a debt management office, we are not specialists in the science behind the investments or the key performance indicators that different investors measure. We talk in basis points rather than in degrees centigrade, or in tonnes of carbon dioxide.

We have to dragoon the efforts and time and resources of several ministries, so we are setting up an inter-ministerial group that is committed to providing the reporting on how green bond proceeds are invested for the long term. Otherwise, everyone contributes initially, then the money comes in and the reporting is harder to keep up with. You have to set up the institutions first.

When those commitments are set up, then we can start with the selection of eligible expenditures, which can take two months and will be based on the budget.

We have certain criteria to consider, such as the selection of impact indicators, which is where we need the environment ministry to contribute. And the science ministry will contribute to the green bond framework, which takes several months to draft and to negotiate.

We have to hire the second party opinion provider and then help it develop its opinion. We have to publish the green bond framework and produce the presentation materials, which is a combined effort. We have to do a specific roadshow, which, hopefully, will take place in person over the summer.

Then we issue and then the reporting begins. By the second half of this year, we will have finished building the infrastructure and by the summer we will be able do the roadshow.

After that we will pick a point in the calendar to issue our green bond. There are a few months to go, but there is groundwork to be covered before, because otherwise, it will become much more difficult later on.