May 18, 2010
Rough road ahead
If the Spanish government wants to pay off its debts and restore its bond rating, it will have to do so the hard way: by cutting spending and raising taxes. In an interview with the Financial Times last month, Zapatero said that his ruling Spanish Socialist Workers' Party would remain committed to austerity measures through the next general election, which is due by March 2012. Zapatero pointed to decisions this year to raise the country's value added tax by two percentage points, to cut new public employment offers to 10 percent of the replacement rate and to cancel an additional €5 billion in investments as evidence of this commitment. Current plans call for annual deficit reductions of 2-3 percent of GDP over the next three years, to bring the country back within the euro area limit of 3 percent of output by 2013.
But deficit reduction will solve only Spain's most acute economic problems. In the long term, the country must be more competitive with its European trading partners. Zapatero says he wants measures to reduce the workday and reform collective bargaining, but so far the government has hedged, facing political pushback from both labor unions and business interests. While reforms like these could cost the Socialists points at the polls, they may also give Spanish employers the leverage they need to reduce wages, cut hours and avoid new layoffs. A reversal of job losses could eventually turn into job growth, which would support spending and output.
In the meantime, investors and Anglo-Saxon scribblers will be watching. Spain faces a rough road ahead. While S&P projected that the country's deficit this year would be more or less in line with the government's target of 9.8 percent, the rating agency also said that the government's projections may by overly optimistic in the medium term. The Spanish government projects real annual economic growth between now and 2013 of 1.9 percent. S&P says 0.6 percent is more realistic. If S&P's growth estimates are correct, then Spain's deficit will still exceed 5 percent of GDP by 2013, while its gross government debt will be more than 85 percent of output. That number will continue to trend higher through the middle of the decade.
Rising borrowing costs could make matters even worse, and could impede the government's ability to reach its targets this year and next. On May 6, Spain paid an average yield of 3.53 percent on the sale of €2.35 billion of benchmark five-year bonds, 72 basis points above what it paid a month ago, and the highest premium on bonds of that maturity since May 2008. The one saving grace for Spain might be that it has a relatively long time to settle its debts compared to Greece and other troubled neighbors. More than 60 percent of medium- and long-term debt held by Spanish institutions is not due to mature until 2014, according to the Bank of Spain.
Whatever happens, one thing that does not seem to be on the table for now is a Greek-style bailout. When told this month of a rumor that he might request a €280 billion rescue package for Spain, Zapatero told journalists in Brussels: "The truth is I give it no credit; it is complete madness."
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