TRANSCRIPT: Interview with Spanish Treasury’s Pablo de Ramón-Laca Clausen on 28 June 2022

1 July 2022

By David Barwick – FRANKFURT (Econostream) – Following is the full transcript of the interview conducted by Econostream on June 28 with Pablo de Ramón-Laca Clausen, General Director of the Tesoro and Financial Policy, Spain’s sovereign debt issuer:

Q: The ECB’s desire to normalise policy has encountered a bit of resistance from markets sceptical about the debt sustainability of Italy above all, but also of other countries on the periphery, including Spain. Is this warranted?

A: No one disputes that the Eurosystem needs to hike interest rates. We’ve had eight years of very low, even negative interest rates because of the fear of deflation. During the pandemic, for example, there was genuine concern that a deflationary spiral was looming. So, accommodative policy was warranted. But now that inflation is in excess of 8%, interest rates need to rise. And we’ve all been preparing for this – the Spanish Treasury, the Italian Treasury, the French Treasury, the German Treasury, and so on. We’ve all been preparing for the normalisation that was bound to come. We all expected it. However, monetary policy is a brittle thing, especially in the Eurozone, which is an incomplete monetary union. The single monetary policy here can snap easily if interest rates are increased quickly and if there is spread volatility, which brings a thinning of the market. We have to make sure that interest rates rise roughly as much in Germany as they do in Italy. The differences between them have to be justified by fundamentals. I’m not saying that every increase in spreads is fragmentation, because that’s obviously not true, but very significant increases in spreads that aren’t justified by economic fundamentals are fragmentation and threaten the transmission mechanism of the single monetary policy. Was the markets’ reaction excessive? Perhaps, because there was some threat of fragmentation. So, I think the ECB does well to use its toolkit to make sure that monetary policy doesn’t break as interest rates are increased for the first time in many years. And I think the anti-fragmentation tool will help the Eurosystem tighten monetary policy more credibly, more quickly and therefore more effectively. So, this is something that has to be done.

Q: But more for the sake of Italy than of Spain, true?

A: At this stage, concerns about debt sustainability are misguided. Debt sustainability isn’t, in my opinion, as yet a concern in any Eurozone country, whether we are talking about Greece, Italy, Portugal, Spain, France or Germany. Debt sustainability is more about the denominator than the numerator. It is misguided to think that any fiscal adjustment that can be constructively and credibly done in Italy would appease market concerns. And let’s remember that Italy has had fiscal surpluses more often than Germany in the past 30 years. The problem with the Eurozone in general is that we need to grow in a synchronised way for the single monetary policy to work for all of us at the same time. When the Economist dubbed Germany “the sick man of Europe”, interest rates didn’t increase as much as they could have, even though Spain was booming. So, current problems involve the technical adjustment to the synchronisation of our economies. I expect Next Generation EU to contribute enormously to putting us all on the same wavelength, because we’re all investing a large amount of our GDP at the same time. We’re conducting industrial policy in a coordinated and planned way. We’ve all extended the average life of our portfolio, so we all have very low refinancing risk. In Spain, around 15% of our debt is exposed to this year’s interest rates. And in the case of Italy and Germany it’s similar. We’ve all also stayed out of trouble and avoided the temptation to enter into complex derivatives that could backfire now. We’ve all been sensible with our debt stock. The numerator of debt sustainability should be relatively under control: the very low rate environment that we’ve had for eight years has transformed our debt portfolio, because we’ve all replaced high-coupon debt with much lower-coupon debt. Right now in Spain, in terms of the interest burden as a proportion of GDP and as a proportion of public revenue, the current debt stock of 117% of GDP – soon to become 115% - is as burdensome for Spain as the 35% that we had in 2005. Such is the effect of the eight years of ultra-low interest rates on our portfolio. And at the same time, we’ve lengthened the average life of that portfolio. What could be a concern at some point is growth, and that is why inflation has to be addressed, because inflation has the potential to impact consumption, investment and confidence. This is why we have delegated to central banks the immense power to increase interest rates. But we don’t want the monetary policy transmission mechanism to break in the process, and this is the justification for the anti-fragmentation tool. It is not out of a concern for debt sustainability. We all understand the need to increase interest rates, and we’ve all been preparing for it.

Q: From your perspective, how does the ECB’s coming new anti-fragmentation instrument need to look?

A: They have all the tools that they need to implement this. Any anti-fragmentation tool has a series of restrictions and a series of advantages that weren’t there 10 years ago. One of the restrictions is that the legal arguments used to justify OMTs are difficult to stray from now. However, this instrument does not intend to address market access of specific countries, because that’s not the issue here; there are other instruments for that eventuality. Another restriction might be the perceived need to sterilise purchases, as the intention is not to increase the balance sheet. I do think they have some advantages that they didn’t have 10 years ago. For one thing, they have an extremely large portfolio of government bonds, that they’ve already purchased under the pandemic emergency purchase programme. They have bonds from every country. I believe this balance sheet can be used to stop undue speculation about spreads, which creates volatility. I think there will be a series of options on the table; it’s not mere rhetoric when I say that they’ve shown that they have more than enough tools, and more than enough ability, to design instruments that work within their mandate. And so I’m very confident that interest rates can increase without monetary policy breaking. That’s what we’re all talking about; the market is not asking for more QE. We all understand that interest rates have to increase and the balance sheet has to decrease. We just need to preserve the integrity of the monetary transmission mechanism.

Q: Was it overly optimistic of the ECB to think it could tighten monetary policy without first providing for the existence of such an instrument?

A: In my humble opinion as an issuer, the increase in spreads was a surprise to most market participants. It’s not just the increase in spreads, it’s the thinning of the market as volatility expels certain investors from the market. Because it comes in conjunction with the war in Ukraine, with inflation and with other concerns, all supply-side driven and all external to the Eurozone we must be nimble and adapt to these circumstances. The anti-fragmentation tool was talked about months ago, but there didn’t seem to be universal agreement that it would become necessary. Having seen the reaction in the past few weeks, it turns out now that monetary policy could risk being impaired if the necessary tightening happens quickly. And so it’s only wise that they are considering this and designing a contingent tool to ensure that this doesn’t happen.

Q: How do you assess the current risk premium of Spanish sovereign bonds?

A: Right now, our spread to Germany is 109 basis points, which is what it was before our latest syndication. It had risen to 138 at the height of the tensions on June 14, and the average year-to-date has been 95 basis points. The Spanish spread against Italy is back to 84 basis points, having risen to 106. So, the reaction wasn’t excessive, but it was surprising. It was far from what we saw 10 years ago, when the Italian spread against Germany rose to 600, 700 basis points. That’s not a unified monetary policy. I would say that there is a level of increase in spreads that is compatible with the end of the asset purchase programme. That’s perfectly accepted. But the speed and the volatility of the increase in spreads had potentially very damaging consequences. You don’t usually have an ad hoc meeting of the ECB with a 250-basis-point spread between Italy and Germany, and I thought that was a very good sign that the ECB showed it is very much on top of this. We have higher debt levels than Germany, and a very different industrial structure. On the other hand we’ve been growing faster than Germany in the past few years, and Germany will have to revise its growth model,. On the whole, there are fundamental differences between Spain and Germany that can justify a certain spread. It’s just the fear of transcending certain thresholds beyond which the market thins out so much that it breaks and we get to spreads that are not based on fundamental differences and instead reflect the fragmentation of monetary policy.

Q: We had comments this morning from an ECB Governing Council member that the ECB shouldn’t necessarily limit itself to 25 basis points in July and 50 in September. Does this seem to you to run counter to the principle of gradualism?

A: I think they have to do whatever it takes to contain inflation expectations. If whatever it takes involves big movements in interest rates, I’m no one to comment. They have the competence and autonomy and one mission. The anti-fragmentation tool enables them to do credibly whatever it takes.

Q: Do you plan to cut your funding target around July as has been the norm in recent years?

A: This year we have unusual uncertainty. On the one hand, our tax revenues are increasing very significantly, so funding needs decline as a consequence of that. On the other hand, payments for Next Generation EU investments are being funnelled out very quickly. After a very long process of public procurement and project design – let’s remember it isn’t a Keynesian stimulus package of spending for spending’s sake, but a comprehensive industrial policy plan -- the plan is now at cruise speed. At the same time, there are many public policy measures that are being implemented to protect households, to protect the production fabric against inflation, so there are selected tax breaks, selected direct aid to certain, very targeted firms, and there is a general decrease in energy taxation. So, there’s a lot that we’re doing on the spending side designed to contain the effects of inflation. So, we are considering how much we’re going to need, and on the basis of that analysis we will decide whether to reduce our funding target. In any case, we are almost two-thirds of the way there. We’ve done three strong syndications and have funded 62% of our medium- and long-term target. So, we’re making very good progress and are more advanced than we were last year before we announced the decrease in our issuance target. That means we have the additional flexibility to see what we do with our funding. So, we’re in a reasonably comfortable position. We will have to fund at higher rates of course, and that’s what we were preparing for, but our portfolio is ready and our funding programme is advanced enough so that we have flexibility to make decisions.

Q: Can you say something about your further syndication plans?

A: Ideally, we plan for around four syndications a year. We’ve done three. We’re well enough advanced in our programme that we don’t need a fourth syndication. We will decide, based on market conditions, whether it would be advantageous and whether demand is there, after the beginning of the tightening of monetary policy. But we are in a position to decide not to do it, because we’ve been issuing strongly even throughout this recent bout of volatility.

Q: What about the possibility of issuing a new green bond this year versus continuing to tap the current green benchmark?

A: Definitely we will continue to tap the current benchmark. Why is this? Because we are limited in how much of our green bond we can issue, because we have to link it with the extremely high-quality projects that we have committed to in our green bond framework, at the same time that Next Generation EU is issuing its own green bonds with our projects. And so, there is a scarcity of very high-quality green projects. That’s where you want to be, and that’s why we all issue green bonds: we want to be incentivised to do green projects. But right now, each European DMO is crowded out by Next Generation EU in its green bond programme. We’re not issuing as much green bond as we would like to or as the market demands, because Next Generation EU is issuing a lot, backed by projects within our budget. So, the buildup of this green bond will be slower than the market would require, and this is why we’re paying a very significant greenium right now. The normal response to a greenium is to issue more green bond, but we are limited in how much we can issue. When the green bond was born in September 2021, it was two basis points. Then we tapped it in two auctions. In the first one, the greenium increased to four basis points, and in the second auction, it increased to seven basis points. We think seven basis points is on the high side, as greeniums go, but we think it will settle at around three to four basis points. That’s what investors are willing to pay for this additional information that they need attached to a bond that they buy. If they want something tailor-made, it is only right for them to pay for the tailor.

Q: Do you think that as the ECB stops net APP purchases the average book size will fall to pre-Covid levels? Is this something that worries you?

A: That’s what we’re seeing, and it really isn’t a problem. A few weeks ago, when we issued a 10-year, the book was €40 billion, which is more than the €30-something billion that the summer 10-year was in 2019. So, we’re getting back to pre-Covid levels. But we mustn’t confuse 10-year syndications in January and June. In January, investors have a blank slate and a lot of money to put to work, and they can place huge orders for the 10-year, because it’s an expected bond and they need to fill their books. So, you can expect bigger transactions and bigger books in January. In June, they have more limited space; it’s a predictable transaction, but books are necessarily smaller. You don’t need a particularly big book, though, you just need a very high-quality book of a certain size. There’s no point in having a €130 billion in your book, some of which is just fluff from hedge funds, if you’re only going to issue €10 billion. So huge books can be burdensome. So, I think it’s a welcome thing that we go back to more real money investors and smaller books, because that makes our job of allocating the bonds easier.