EU focus on Spain after weak bond auction

SPAIN IS coming under renewed political scrutiny in Europe as premier Mariano Rajoy struggles to convince investors that his administration can assert control over the country’s wayward finances.

Despite unveiling €27 billion in austerity measures only a week ago, the government met weak demand for a bond auction on Wednesday. “Spain is facing an economic situation of extreme difficulty – I repeat, of extreme difficulty – and anyone who doesn’t understand that is fooling themselves,” Mr Rajoy told a party meeting in Malaga.

Officials said the euro zone powers were closely examining the auction, in which Spain sold an amount of debt, €2.6 billion, which was just above the minimum target, and paid a higher interest than forecast.

Spanish unemployment is at a record level and the country’s banks are trying to overcome a spectacular property crash.

Although the upsurge in market pressure has taken 10-year Spanish bond yields to their highest level in almost five months, euro zone officials insist they are not unduly concerned and that borrowing costs remain manageable for the moment.

Spain’s national debt is not as high as Italy’s, meaning the country is a little less exposed to short-term spikes in its borrowing costs.

The country is still considered “too big to save” from euro zone bailout funds, meaning any sustained hike in its interest rates would present a grave political problem to EU authorities.

The latest turmoil follows a period of relative calm after the European Central Bank moved, amid a growing sense of crisis last December, to flood the euro zone banking system with €1 trillion in ultra-cheap medium-term loans.

Euro zone officials attribute some of the tensions to Mr Rajoy’s unilateral decision to ease Spain’s budget deficit target this year on the same day as he signed Europe’s new fiscal treaty.

They argue that this “aggressive” manoeuvre, later watered down by finance ministers, raised inevitable questions over the prime minister’s capacity to assert control over the financial situation. “We don’t see that it’s an accident. Spain was very robust about unilaterally changing its deficit target in a very big way,” said an official who is monitoring events in Spain. “It tells you there’s concern in the market about the commitment of the government, so that has to guide your reaction.”

While the official said the government was now obliged to demonstrate to markets that it can overcome its problems, there are no moves for the moment to revise this year’s budget targets.

Mr Rajoy’s centre-right government, which marked its 100th day in power this week, suffered a blow just before the budget when it failed to win a key regional election in Andalusia.

Last week both Spain and the EU Commission denied a succession of Spanish reports that the country was coming under pressure from Brussels to seek rescue aid to boost its crippled banks.

Several Spanish newspapers, quoting a senior European source, said Mr Rajoy was being urged to seriously consider applying for aid.

The Rajoy administration has directed the banks to raise more than €50 billion to restore their balance sheets. However, Spanish papers quoted the source as saying rescue aid was the only feasible way of raising much of this capital as private investors were wary and the government could not afford to contribute.

The euro zone official said the size of the Spanish economy meant it was unlikely to be a candidate for a full-blown bailout along the lines of the EU/IMF programmes for Ireland, Greece and Portugal. Officials believe it would be unwise to fully remove the country from private debt markets if borrowing costs rose to an unsustainable level.

Alternatives include a partial withdrawal from private markets, a leveraging of bailout fund aid or a partial guarantee over bond issues by the fund.