Monday, March 1, 2010

Markets Poised To Punish Spain

Markets Poised To Punish Spain

By Victor Mallet, FT | 28 February 2010

Miguel Angel Fernández Ordóñez, governor of the Bank of Spain, needed only one sentence to summarise the daunting scale of the challenges facing his country. "Unfortunately," he told a conference last week, "we find ourselves at a historic moment". With characteristic tartness, he was referring to Spain's urgent need to curb public spending and liberalise a labour market that has left more than 4m people unemployed. Reforms are needed to make the economy more competitive and give the Socialist government's austerity plan at least a chance of success.

Whatever happens in Athens, and regardless of whether stronger economies such as Germany are finally obliged to rescue the crisis-stricken Greeks, it is all but certain that the markets will soon turn their icy gaze once more on the other vulnerable economies of the eurozone. Spain's economy is four times the size of Greece's. It is by far the largest of the budgetary laggards that will be facing renewed scrutiny, and probably higher financing costs, in the sovereign debt markets.

The crucial issue for Spain and its European neighbours is the credibility of its "stability plan". Spain's government outlined sharp cuts in government spending, including a near-freeze on hiring civil servants. It aims to reduce the deficit from 11.4 per cent of gross domestic product last year to 3 per cent of GDP in 2013. Although it will have no short-term impact, Madrid has also proposed increasing the retirement age to 67 from 65 to secure the financial health of the pensions system.

José Luis Rodríguez Zapatero, prime minister, faces an uncomfortable spring, for very few economists, analysts or foreign investors are convinced either that the plans are plausible or that the government has the will or ability to implement them. "It is all air," said Luis Garicano, professor of economics and strategy at the London School of Economics, "just ideas that for the most part the government cannot put in place by itself, particularly on pensions or public employees". Nomura said it was "not convinced" that the austerity plan could be implemented. Standard & Poor's, the rating agency, predicted that the budget deficit would stay above 5 per cent of GDP until 2013, well above the eurozone's widely abused 3 per cent limit.

Critics of the austerity plan, which has been sent to Brussels for approval, point to three main obstacles. First, its economic forecasts are over-optimistic. Second, central government has direct control over only about a quarter of expenditure, with the rest disbursed by autonomous regional governments and the social security system. Third, the Socialists lack the necessary will. When they talk to foreigners, Spanish ministers say they are determined to do whatever it takes to restore order to their public finances. But when they address their supporters at home, they emphasise plans to maintain social spending.

The result is confusion and disarray. While José Manuel Campa, deputy finance minister, was sweet-talking bond investors in London with talk of budget discipline, José Blanco, public works minister and a senior Socialist, was back home berating foreign "speculators" and hinting at a foreign media plot against Spain and the euro. And a day after another deputy minister suggested the possibility of a public sector pay freeze to bolster the budget plans, Elena Salgado, finance minister, ruled out any such thing.

Mr Zapatero and his ministers, like their foreign peers, deserve some sympathy for their post-Keynesian hangover. At a meeting in London this month Mr Zapatero recalled that the same organisations and markets that had demanded massive fiscal stimulus to avert an economic depression were now complaining about the resulting fiscal deficits. "What a paradox. What a contradiction," he said.

The bad news for Mr Zapatero and other deficit-burdened European prime ministers is that the markets, impersonal yet fickle, do not give a damn about paradoxes or who was to blame yesterday for a problem today. Spain must, for its own sake and that of the eurozone, implement the measures announced with unwavering determination— and make them even tougher if the recession lasts longer than expected. Ms Salgado and her colleagues say they will do just that. The problem is that not enough people believe them.



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