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Spain on the precipice

VIDYA RAM
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VIDYA RAM
VIDYA RAM

When the meeting of Euro Zone finance ministers last month concluded with an agreement to provide Spain with up to 100 billion euros (Rs 681,800 crore) to assist its ailing banking sector, the Prime Minister, Mr Mariano Rajoy, was triumphant — proclaiming the agreement as a “victory” for both the euro and his nation.

Seven weeks on, and the situation in Spain seems a world away from that upbeat assessment. Yields on government bonds spiralled mercilessly in a direction that makes many believe that a sovereign bailout is all but inevitable.

In fact, we know that the matter of a 300-billion-euro (Rs 2,055,000 crore) bailout was discussed at a recent meeting of the finance ministers of Germany and Spain (according to a senior official who spoke to Reuters news agency).

Spain’s economic woes only seem to be getting worse: the latest figures from the Bank of Spain show that GDP shrank 0.4 per cent quarter on quarter in the three months to May, against a previous contraction of 0.3 per cent, and is only set to get worse as further austerity sinks in. The government isn’t expecting growth to return till 2014.

Meanwhile, the labour market continues to deteriorate, with unemployment reaching a worrying 24.6 per cent in the second quarter. The situation for under-25s is even direr — more than half of them are unemployed.

Conditions in the already-struggling housing market continue to get worse, with the drop in prices only accelerating, according to the most recent data. These conditions may only get worse with the austerity measures in store for the nation.

PUNISHING CONDITIONS

Mr Rajoy has topped up the austerity measures introduced by the previous government, bringing in hikes to income tax and cuts to the public sector payroll, among other things.

However, the country has continued to struggle with its deficit (the substantial leeway for regional governments had made the job of the centre even more difficult) and in March, the government announced that it would no longer be able to meet its targets for the year.

Now, the country faces even more punishing conditions, with a plan for further tax increases (including, very controversially, to Value Added Tax) and spending cuts (including to unemployment benefit) totalling a staggering 65 billion euros (Rs 442,400 crore).

Meanwhile, the extent of the crisis of Spain’s 17 debt-ridden regional governments — whose revenues were shattered by the collapse of the housing market and the troubles of regional banks — is only just becoming clear.

Last week, Valencia, which has a debt pile of 20.8 billion euros (Rs 1,42,900 crore) requested assistance from the central government’s 18-billion-euro fund for regional governments to help it refinance some 2.8 billion euros (Rs 19,000 crore) worth of debt this year. Others are expected to follow shortly.

“Despite being Spain’s wealthiest autonomous region, Catalonia appears a likely candidate, given that it remains the most indebted,” says Raj Badiani of IHS Global Insight. The region’s debts stand at 42 billion euros (Rs 2,86,000 crore) in the first quarter.

“Economically we have to admit it’s going very badly in Spain,” says Carsten Brzeski, an economist at ING Bank.

“The banking crisis has begun to be tackled and we will slowly learn whether it’s sufficient or not, but we have the economic problem — driven by high unemployment and a lack of competitiveness, which will take a very long time to fix, and regional problems which will only make the state of public finances worse.”

DECLINING POPULARITY

All in all, the situation is a particularly nightmarish one for Mr Rajoy, who swept to victory at the helm of the Popular Party in elections last November.

At the time he warned that sacrifices would have to be made, but also seemed defiantly optimistic. “We will stop being part of the problem and will be part of the solution,” he promised the nation.

Since then, his popularity has plummeted: according to a poll conducted for national newspaper El Pais last month, 78 per cent of people distrust Mr Rajoy, while the party’s standing in the polls dropped from 44.6 per cent at the time of the election to 37.1 per cent — a steep fall for just seven months.

This is despite the fact that the opposition Socialist party also remains highly unpopular (85 per cent distrust their leader, Mr Alfredo Perez Rubalcaba). Demonstrations against government policy have become a common sight in cities across the country.

Earlier this month a group of former coal miners trekked hundreds of kilometres to join a protest in Madrid.

Part of the problem, says Santiago CarboValverde, Professor of Economics at the University of Granada, is that Mr Rajoy has gone back on much of what he promised.

“He clearly stated during the campaign that there would be no VAT and tax increases, but he hasn’t fulfilled his promise, so even the Spaniards who voted for him are not happy.”

IN DENIAL

Adding to his credibility gap has been the overly optimistic picture his predecessors and he painted of the nation’s situation, despite the danger signs. “If you spend four years telling people that the country doesn’t have a substantial crisis, does not need a banking bailout, and the green shoots will emerge very soon, you put people in denial,” says Prof CarboValverde.

Denial is something the nation may be forced out of soon — should the bailout, that many believe is highly likely, come through.

It is unlikely to be immediate: Bond yields have fallen below the perilously high 7 per cent plus levels they reached earlier this week, after President of the European Central Bank, Mr Mario Draghi, said that they would do all within their power to save the euro — a move that many took to mean buying Italian and Spanish debt on the secondary market.

However, pressure may increase towards the end of the year, when Spain will face the task of refinancing billions of euros of maturing debts.

BAILOUT BLUES

The worrying thing is that while a bailout may ease the pressure on Spain, it may only heighten fears about the Euro Zone.

The 300 billion euros (Rs 2,055,000 crore) that Spain is estimated to need would amount to three-fifth of the European Stability Mechanism, the yet-to-be-implemented bailout fund that was meant to be the region’s bazooka for the crisis.

This would leave little room, should things continue to sour in Italy. Even more troublingly, the implementation of the ESM continues to be held up by a court challenge in Germany.

For the moment this leaves us with its predecessor, the EFSF that, if we deduct its existing commitments, has 120 billion euros (Rs 8,17,000 crore) to spare.

As ever, rather like trying to solve a Rubik Cube, each move forward by European leaders can make a final solution seem even further away than ever.


A humungous bailout for Spain may squeeze resources for the next country in line, Italy.


(This article was published in the Business Line print edition dated July 30, 2012)
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