Spanish circle getting hard to square
The art of politics is about squaring circles. In the euro crisis, this means pushing ahead with painful but necessary reforms while hanging onto power.
In Spain, where I spent part of last week, these circles are getting harder to square. Mariano Rajoy isnât at any immediate risk of losing power. His 10-month old government has also taken important steps to reform the economy – cleaning up banks, liberalising the labour market and reining in government spending.
But the recession is deepening, the prime minister is a poor communicator and his political capital has plummeted. Madrid will also find it harder than thought to access help from its euro zone partners.
GDP will shrink by 1.5 percent this year and another 1.8 percent next year, according to Funcas, the Spanish savings bank association. That is a result of both a severe fiscal squeeze and private-sector deleveraging. An austerity spiral is in operation. As the International Monetary Fund argued last week, so-called fiscal multipliers across the world are bigger than forecasters had previously estimated.
The severity of the downturn means the government seems destined to miss its deficit reduction targets again. This year, Madrid economists think it will end up with a deficit of around 7 percent of gross domestic product, against a revised target of 6.3 percent. Next year, the deficit could be in the 5-6 percent range rather than the new, 4.5 percent target.
It might seem that these slippages matter less now that the IMF and even some euro zone policymakers are softening their demands for austerity. Foreign governments are less likely to demand Madrid tighten its belt further if a failure to hit targets is not its fault.
However, Spain will have to sell 207 billion euros of bonds, equivalent to 20 percent of GDP, next year – to fund the deficit and rollover maturing debt. Thatâs even more than the 186 billion scheduled for this year – an amount Madrid has only been able to shift because the European Central Bank lent 230 billion euros of cheap long-term money to Spanish banks, much of it recycled into buying government bonds.
Spain should be able to sell the remainder of this yearâs bonds because investors have been lulled by the ECBâs promise to purchase unlimited amounts of sovereign paper. For example, they brushed aside last weekâs two-notch downgrade of the countryâs credit rating by Standard and Poorâs. But as next year approaches, the mood could turn ugly – especially if Madrid hasnât by that time taken advantage of the central bankâs security blanket and its credit-rating is junked.
Investors could start worrying about the fact that the stateâs debt could well reach 100 percent of GDP in 2015 after including the cost of injecting capital into the banking system. They may also focus on the fact that the ECBâs bond-buying plan is partly a confidence trick because it is limited to the secondary market and short-term bonds – and would end if Madrid couldnât sell bonds in the primary market. A loss of confidence could be self-fulfilling.
Why doesnât the government just get on with it and ask for ECB help? That would lower the risk of a renewed âSpanicâ attack and cut both the governmentâs and the private-sectorâs borrowing costs – taking the edge off the recession.
Before I went to Madrid, I thought Rajoyâs misplaced pride was the main reason he was not asking for help. This, and the desire to wait until after regional elections in Galicia later this month, may be minor factors. But the two more important reasons for delay are lack of clarity over what the ECB will do and concern that Germany will block the bailout.
Does the ECB just want to cap Spanish 10-year bond yields at around the current level of 5.7 percent? Or does it want to drive them down to, say, 4.5 percent – the level that might be justified if there werenât residual fears about a break-up of the euro? Rajoy hasnât asked Mario Draghi, the ECBâs president. Even if he did, he wouldnât get a straight answer. But it should still be possible to get some rough sense of what the ECB wants.
The bigger issue is Berlin. The ECBâs bond-buying scheme is contingent on a parallel programme being agreed between Madrid and the other euro zone governments. Unfortunately, Germany has been saying that it doesnât think Spain needs help. That, in turn, seems to be mainly because Angela Merkel, the chancellor, doesnât want to have to push another bailout programme through the Bundestag only three months after it got parliamentarians to agree to a mega-loan for Spainâs banks. Sentiment in Germany towards bailouts in general and the ECBâs bond-buying plan in particular is negative.
Madrid has seen how Berlin is seeming to renege on an earlier plan that would have allowed it to transfer the cost of bailing out its banks to the euro zone rather than just receive a loan. It now doesnât want to ask for help only to be turned down.
If there is another panic, Merkel will presumably decide to get parliamentary approval for Spanish aid. It is also possible that she will push a package deal through the Bundestag next month covering not just Spain but also Greece and Cyprus. But it would be far preferable to act before then. Sadly, that isnât the way Europe, despite its new Nobel Peace Prize, normally works.