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April 10, 2012

Spain the focus of New European Crisis

Business Week - Things are unraveling in Europe at a startling pace. The country in the greatest danger is Spain, which could become the fourth member of the euro zone to require a bailout, following Greece, Ireland, and Portugal. Spain’s 709 billion euros of sovereign debt is roughly twice the debt of those three nations combined, according to data compiled by Bloomberg, so a rescue of Spain would be a heavy burden for the rest of Europe.

Investors got overconfident in Spain after the European Central Bank announced last December that it would funnel cheap, three-year loans to European banks, which they could (and did) use to invest in the debt of their own nations. The ECB lent more than 1 trillion euros. Spanish government 10-year yields, which were over 7 percent last November, plummeted to below 5 percent this January and February. But they have raced back upward to just below 6 percent in recent weeks.

Spain’s yields started jumping in early March after Prime Minister Mariano Rajoy announced that the government budget deficit would miss the 4.4 percent of GDP target the previous administration had agreed to with the European Union. The problem is that the easy money from the ECB didn’t do anything to fix Spain’s fundamental problems—overindebtedness and an uncompetitive economy that, because of the common currency, can’t use depreciation as an escape hatch.

NY Times- Spain is entering its second recession in just three years, and the government expects the economy to contract by about 1.7 percent in 2012. With unemployment of around 23 percent, there is fear that austerity measures — deemed critical for winning back market confidence — could have the perverse effect of further depressing growth and creating a vicious cycle in which more budget cuts are needed to balance the public books.




Prime Minister Mariano Rajoy is counting on a squeeze of €27 billion in the central government budget to bring the deficit down to 5.3 percent of gross domestic product this year, with 3 percent then targeted for 2013.

On Monday, Mr Rajoy also warned regional governments to cut their annual spending on health care and education by €10 billion as part of their own austerity drive. The regions accounted for two-thirds of Spain’s budgetary slippage last year, which resulted in an overall deficit of 8.5 percent of G.D.P., compared with a 6 percent target.
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