What is the risk premium and how does it affect the Spanish economy?

JD
Updated: 03/05/2022 19:17h
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During the debt crisis of a decade ago, when the Spanish economy bordered on rescue, the risk premium became a reference indicator to take the temperature of the country's financial health. During the summer of 2012 the score easily exceeded 600 points. In recent days, and for the second time so far in 2022, the Spanish risk premium has returned to three figures, with a closing peak on Monday, May 2, of 106 basis points. Without the urgency of a decade ago, it is convenient to remember what the risk premium is and why it is important.

What is the risk premium

The risk premium is an extra cost.

It is the percentage amount that a debt issuer pays -in this case, a country- on an agreed reference unit. Thus, in the case of the risk premium, the ten-year German bond -'bund'- is taken as a reference to calculate the extra cost that is added.


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In other words: the German economy is considered the safest in the eurozone, and therefore its bonds are considered the least risky. In order to attract investors, the rest of the countries have to add a higher return than the German one, on the one hand to compensate for the risk of the investor, who opts for a less secure option, and on the other to, through this higher return, capture more money in debt issues, money that will later be invested in the country.

In the 2012 crisis, every 100 basis points of increase in the Spanish risk premium meant the destruction of some 160,000 jobs, according to BBVA

The problem of 2012 arose precisely because of the poor economic health of Spain and the so-called PIIGS (Portugal, Greece, Italy, Spain, by their English names, plus Ireland). As the risk of bankruptcy was greater, and therefore the investor's risk of losing his money if the State that owned the debt went into 'default', the debt-issuing country offered a greater return to tempt investors and raise funds . That higher return needed to finance itself was precisely what raised the Spanish risk premium to unprecedented levels.

According to what Francisco González, then president of BBVA, pointed out in 2012,
every 100 basis points
which scales the Spanish risk premium meant the destruction of some 160,000 jobs and 1.2% of annual GDP.

How is the risk premium measured?

The risk premium is measured in basis points. A basis point is one hundredth of one percent, or 0.01%. If the risk premium of a country reaches the value of 100, for example, it means that the profitability of its debt, and therefore, the return that it must offer to the investor for buying it, is 100 times 0.01%. That is to say, 1 percent more with respect to the yield of the mentioned German bond to ten years.

Simply explained: if the ten-year German bond has a yield of 1%, the 10-year Spanish bond, with a risk premium of 100, must be 2%, 3% if the premium is 200, 4 % if it is 300, and so on.

The risk premium, now

As of May 3, 2022 (the risk premium is a value that is updated and changes throughout the day, such as the value of the IBEX-35), Greece's risk premium is above 230 basis points , with a rise of more than 110 basis points since the start of the year. Portugal has reached 109 (+41 basis points since the beginning of the year) and Spain is around 105 (+38 since January 1, 2022).

It should be remembered that the percentage of Spain's debt with respect to its GDP (that is, how much the country owes with respect to how much it has produced in a year) closed in 2021 at 118.40%, according to
DataMacro
. In 2008, before the start of the economic crisis, it did not reach 40%: 39.70%.

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