Little relief for Rajoy as Spain's problems continue to pile up

Thu, Apr 19, 2012, 01:00

EUROPEAN DIARY:SPAIN’S LATEST brush with danger comes four months after Spanish prime minister Mariano Rajoy took office with a mission to bring the country’s ailing economy to heel. The big question now is whether he can avert an international bailout.

Borrowing costs are on the rise again, unemployment is at a record level and the magnitude of property loan losses in the country’s bombed-out banking system is still unknown. It doesn’t end there. People in Brussels say it is only recently that the Rajoy administration has really come to terms with gravity of its task. “They are finally concerned,” an official says ruefully.

Precious time was wasted as the government prioritised an ultimately unsuccessful regional election campaign in Andalusia over its 2012 budget, which was delivered only at the end of March. Worse, conflicting signals over the deficit-cutting goal raised questions over the government’s strategy.

Rajoy unilaterally declared last month that he would strip less from the budget by targeting a higher deficit than approved by Europe. The insistent response from Brussels was that the public finances would be none the better for foregoing cuts, as doing so would add to the country’s interest costs. So it came to pass.

Although the delayed 2012 budget embraces a mammoth €27 billion austerity blitz, bond yields have crept upwards since.

Last Monday the interest rate on 10-year bonds breached the all-important 6 per cent threshold for the first time this year, something received as a grim reminder that the debt crisis remains a potent threat.

Outside Spain, Rajoy is still seen as something of an unknown quantity. The scepticism he encounters on markets is in contrast to benign attitudes towards his technocratic Italian counterpart, Mario Monti.

In a move not dissimilar to Rajoy’s unexpected adoption of a higher deficit goal, Monti said yesterday he would delay by a year his target for achieving a balanced budget in order to promote economic growth.

Monti has the benefit of a lower budget deficit than Spain, but the muted market response to the demarche points to a level of credibility that Rajoy cannot match. The Spanish leader received a drubbing when he relaxed his deficit target.

Even so, the question still arises as to whether he is introducing too much austerity for the country’s own good. Whatever the answer, his task is all the more difficult due to the high proportion of public spending by Spain’s autonomous regions.

These account for some 30 per cent of expenditure, and the lack of adequate controls is widely held to be behind the overshooting of last year’s deficit target. Originally set for 6 per cent, this is now estimated to have come in at 8.5 per cent by year-end. The final figure will be disclosed next Monday by the EU’s statistical agency, Eurostat.

The government is already talking about taking budgetary powers away from the most wayward regions, reversing a decades-long process of devolution. That will be tricky. By the end of this month it must also tell the European Commission how it proposes to achieve a 3 per cent budget deficit next year, necessitating a further bout of cutbacks and tax measures.

Then there are the banks. Madrid has already directed them to raise €50 billion in new capital, raising inevitable doubts over the willingness of private investors to step forward with their cash. Madrid doesn’t have the money either, leading to whispers that European Financial Stability Facility aid will be required.

This is routinely denied. In all likelihood, however, any external aid for Spain would be tailormade for its banks. This is permissible within the EFSF framework.

The thinking here is that Spain is too big to be fully taken out of private debt markets. At the same time, few observers believe €50 billion would be sufficient to rescue the banks. More will be required, but how much remains to be seen.

Still, new research from Centre for European Policy Studies analysts Cinzia Alcidi and Daniel Gros cites a “very rough” estimate that the Spanish construction and property sector has an accumulated debt overhang of some €380 billion.

The writers draw a comparison with the Irish property flameout, saying the post-crash adjustment has taken place at high speed, with one-third of the bubble already absorbed.

“While some adjustment has occurred since Spain’s housing bubble burst in 2008, house prices and construction need to decrease more to slow Spain’s unsustainable accumulation of foreign debt,” they say. “It goes without saying that our estimated total of €380 billion exceeds by far the provisions and writedowns accumulated by the Spanish banking system (and in particular the savings banks) so far.”

A further complication is that the European Central Bank is resisting any resumption of its bond-buying campaign, which shored up demand for Spanish and Italian bonds at crucial points last year.

The ECB is also reluctant to repeat its €1 trillion cheap-loan scheme for euro zone banks, much of which was recycled by Spanish and Italian banks to buy up government bonds. Their sovereign debt holdings rose by €122 billion between November and February.

The upshot of all this is that risk is increasingly concentrated within Spain itself and that foreign private investors are more and more sceptical about Rajoy’s efforts to steady the situation.

He needs to borrow more than €80 billion from markets this year and has already raised almost half Spain’s requirement.

This provides a small measure of comfort, but problems are piling up rapidly.