Now, Spanish flu

A Greek-style bailout looks inevitable

The breather from the Greek debt crisis might prove all too short-lived as another Club Med country appears to be in danger of catching the financial contagion: Spain. As Prime Minister Mariano Rajoy gets ready to present a deficit-cutting Budget on March 30, labour unions are preparing for a strike to protest against laws that make it easier to fire workers and cut wages. All this takes place against the backdrop of a meeting of euro zone finance ministers in Copenhagen on Friday to strengthen the region’s “financial firewall” by raising the ceiling on bailout funding. Much of this is contingent on how far Spain is ready to bite the bullet of austerity. And the country is clearly struggling. Last month, it informed the European Union (EU) that it would miss its 2011 deficit reduction target of six per cent of gross domestic product (GDP) by as much as 250 basis points, in spite of an austerity plan. Given the 2012 deficit reduction target of 4.4 per cent of GDP, Mr Rajoy, who came to power in December and leads a pro-business party, has his work cut out. According to one calculation, unless Spain gets some relief on its deficit target, Mr Rajoy will have to pile on a 167 per cent increase in austerity measures to meet the 2012 target.

Mr Rajoy has said his spending cuts won’t include increases in tax on consumption or a reduction in civil servants’ salaries. It is hard to see how he will be able to avoid this given that the headroom for raising revenues is strictly limited. The Spanish economy shrank 0.3 per cent in the fourth quarter last year and unemployment is at 23 per cent. Meanwhile, the Bank of Spain on Tuesday predicted a further contraction for the economy in the first quarter of 2012. Under Spain’s shared structure of governance, it is the regions that are responsible for many spending decisions, and few are on board with the austerity plans.

To be sure, Spain enjoyed some relief with the European Central Bank’s trillion-euro release of cash to its banks, with which they bought the country’s sovereign debt. But investor pessimism has not abated, visible in Tuesday’s sale of securities at which the Spanish Treasury reportedly had to pay 0.836 per cent to sell six-month bills against 0.764 per cent a month ago. In other words, another Greek-style bailout that involves sharper austerity and a hair cut for bondholders cannot be ruled out. Like Greece, Spain may well have run out of options. Many analysts insisted that Greece could do better by exiting the euro zone, and if it did the consequences for the euro zone would be negligible, as Greece accounts for under two per cent of the EU. But Spain is Europe’s fifth-largest economy, accounting for almost nine per cent of the EU. This, therefore, is Europe’s real test case.