Spanish debt downgraded as labour talks fail to secure reform consensus

THE EURO’S brief respite came to an abrupt halt with a second rating agency downgrading Spanish debt as labour reform talks ended without success, increasing pressure on premier Jose Luis Zapatero.

With market sentiment weakened by lacklustre US economic data, the euro resumed its slide to drop 0.1 per cent against the US dollar to $1.2354 at midday in New York. Down 7 per cent this month, the currency has been under exceptional pressure in the fallout from the Greek debt debacle.

Fitch yesterday cut Spain’s credit rating from AAA to AA+, reflecting its assessment that “the process of adjustment to a lower level of private sector and external indebtedness will materially reduce the rate of growth of the Spanish economy over the medium-term”.

Standard and Poor’s cut Spain’s ratings to AA on April 28th.

Despite repeated efforts to present a united front, European leaders remain glaringly at odds with each other over the response to the crisis. In the latest sign of tension, European Central Bank (ECB) executive board member Lorenzo Bini Smaghi implicitly criticised the claim by German chancellor Angela Merkel that the crisis endangers the currency.

“In one large euro-area country it was thought that public support for swift action could be achieved only by dramatising the situation – for instance, by telling the public that ‘the euro is in danger’,” he said in Morocco. “But it was not realised that, in the midst of a financial upheaval, such words are like fanning the flames and that the cost of the support package could only increase following such dramatic declarations.”

After parliament in Madrid backed Mr Zapatero’s €15 billion austerity plan by a single vote, his minority socialist administration is threatening to ram through controversial changes to the country’s rigid labour laws if there is no deal by Monday.

Even amid mounting concern about the country’s economic prospects, any enactment of the labour reforms by a royal decree risks worsening the government’s confrontation with unions over pay and pension cuts.

Unions have already threatened to call a general strike if Mr Zapatero unilaterally enforces the reforms.

With Spanish unemployment already at 20 per cent, Mr Zapatero only reluctantly agreed this month to make cutbacks in the face of mounting market pressure and pleas from his EU colleagues.

Having lost the support of Catalan and Canary Island nationalists and another regional group over the cutbacks, Mr Zapatero’s position appears increasingly precarious.

Given the absence of a national consensus over a strategy to tackle the financial crisis, his weakness has presented a clear political opportunity to the opposition, led by the conservative Popular party.

Alongside Portugal, Spain is seen as one of the euro-zone countries most vulnerable to contamination from the Greek debt debacle. The cutbacks are designed to reduce the budget deficit to 9.3 per cent this year and 6 per cent in 2011, from 11.3 per cent in 2009.

However, the government yesterday cut its growth forecast for 2012 to 2.5 per cent from a 2.9 per cent, and for 2013 to 2.7 per cent from 3.1 per cent.

Madrid’s seizure of a regional savings bank last weekend sent markets down as it underscored the vulnerability of weak European banks as the authorities try to gain the upper hand in a crisis that led them and the IMF to promise €110 billion in loans to Greece and €750 billion in loan guarantees for other distressed members of the currency.