Pressure on Spain as IMF seeks action on weak finances

THE SPANISH government came under fresh pressure as the International Monetary Fund called for “additional action” to anchor its feeble public finances and Moody’s put the country’s debt on review for a possible downgrade.

The warnings came as Socialist prime minister José Luis Zapatero called a general election in November, four months ahead of schedule, in an attempt to take advantage of a small increase in his government’s poll ratings.

The focus on Spain comes as pressure on Italy persists, even after euro zone leaders sought to contain the spread of contagion from the debt crisis by expanding the remit of their bailout fund.

A deepening political crisis in Cyprus has also raised new fears that it might need a bailout. Rating agency Standard Poor’s downgraded Cyprus last night, citing “fiscal concerns” and the country’s exposure to Greece.

As it signalled a possible downgrade on Spain, Moody’s said the new package from euro zone leaders “has not relieved market concerns” on the position of weakened sovereigns because it sets a precedent for private sector participation in future debt restructurings. The agency also said it was unclear when the proposed expansion of the bailout fund’s powers will be implemented.

Ravaged by high unemployment and weakness in its banks, Spain has been in the firing line of the sovereign debt crisis for more than a year. Until attention turned in recent weeks to Italy, the country was perceived to be the most vulnerable of Europe’s major economies as it tries to reverse its worst recession in 60 years.

Political pressure on Mr Zapatero led him to signal months ago that he would seek a third term. In spite of a modest rise in its poll ratings, his party is still forecast to lose the election to the centre-right conservative opposition.

New data released yesterday underscore the depth of the challenge Spain faces as it battles to avoid to avoid the fate of Greece, Ireland and Portugal, the euro zone’s three bailout recipients. While the unemployment rate dipped a little in the second quarter, it remained well in excess of 20 per cent, at 20.9 per cent.

In an update, the fund praised Spain’s “strong and wide-ranging” crisis response, but said downside risks dominate as the economy recovers gradually. “Unemployment remains unacceptably high, inflation is again above the euro area average and sovereign and bank funding costs remain elevated and volatile,” it said.

“The policy agenda remains challenging and urgent – there can be no let-up in the reform momentum. Ambitious fiscal consolidation is under way but is based on optimistic macroeconomic projections, and there is a risk of some regional governments missing their targets. Anchoring fiscal sustainability requires additional action. The financial sector reform needs to be decisively completed. This needs to be complemented by a bold strengthening of labour market reforms to substantially reduce unemployment, and following through on the structural reform agenda to spur productivity and employment.”

Moody’s said its review of Spain was driven by continued funding pressures on Madrid, adding that the precedent set by efforts to enlist private creditor support for the second Greek bailout would exacerbate such pressure.

Moody’s expressed concern about the weak growth environment for Spain and about continued fiscal slippage in “several” of its regional governments.

“Funding costs have been rising for some time for the Spanish government and for many closely related debt issuers, such as domestic banks and regional governments,” it said.

“Pressures are likely to increase still further following the announcement of the official package for Greece, which has signalled a clear shift in risk for bondholders of countries with high debt burdens or large budget deficits.”

Moody’s said it had a positive view of Madrid’s effort to meet its near-term fiscal consolidation targets but noted “challenges to long-term budget balance remain due to Spain’s subdued economic growth”.