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The Globe and Mail

Spain’s new austerity buys time, not solution

Off-duty police officers and fire fighters protesting austerity measures are held back by police officers outside the Parliament building in Madrid July 12.


Spain may have won some time with markets and praise from Europe but it has little left in the locker to avoid a state bailout. A new €65-billion austerity program could deepen the country's economic woes rather than solve them, analysts say.

The measures announced on Wednesday saw Prime Minister Mariano Rajoy backtrack on many of the pledges he campaigned on six months ago, to meet demands made by the European Union and put the Spanish economy under de facto external administration.

The austerity plan was a condition for being given an extra year to bring the public deficit in line with EU rules and for an up to €100-billion bailout of the country's crippled lenders. But neither concession will put Spain on the path to recovery.

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Ailing banks, badly hit after a decade of unsustainable lending ended with a property crash four years ago, coupled with highly indebted regions have pushed Spanish borrowing costs though the roof.

Investors and analysts are worried that the latest measures will only make things worse for a country already in recession which, if it deepens, will cut government revenues and make even the newly relaxed debt targets harder to meet.

"It doesn't address the funding issue and the problem of a lack of demand. It will only cut the revenues, the capacity to generate jobs and will even make more difficult to repay the debt," said Juan Torres Lopez, professor of economics at the Seville University. "The deficit targets will also be more difficult to meet."

Mr. Rajoy, in parliament to spell out the pain in person, announced a three-point hike in the main rate of value-added tax on goods and services to 21 per cent and cuts in unemployment benefits and civil service pay and perks in a speech interrupted by jeers and boos from the opposition.

He also announced new indirect taxes on energy, plans to privatize ports, airports and rail assets, and a reversal of property tax breaks that his Popular Party restored last December.

Spain's 10-year debt yields eased immediately after Mr. Rajoy presented the biggest savings plans of the past 30 years, but they rose again on Thursday, to 6.65 per cent.

An EU summit last month gave a green light for the euro zone's ESM rescue fund to intervene on the bond market to lower borrowing costs and, once a cross-border banking structure is set up next year, to recapitalize banks directly rather than having to lend to governments with strict contingencies attached.

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Without such help, analysts see little hope that Spain's borrowing costs – it cannot afford to pay up to 7 per cent indefinitely – will fall.

Therein lies a further problem, with Germany's top court defying pressure for a snap verdict to allow Berlin to ratify the fund, potentially delaying its inception until the autumn.

"Spanish Prime Minister Rajoy appears to have pulled off a minor success in his operation 'confidence repair' … but it will not switch on the light in the dark tunnel of recession the country finds itself in," said Societe Generale in a note to clients.

"With some EU member states starting to criticize greater fund transfers more openly and Germany's constitutional court in no rush to cast a verdict on the legality of the ESM, one cannot help but wonder if Spain still is in control of its own fate."

The Spanish government, which previously said the economy would grow by 0.2 per cent next year, is now anticipating that it will contract until the end of 2013.

It would be the first time the country has experienced a recession for two consecutive years since 1957 and 1958, under the dictatorship of Francisco Franco.

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Mr. Rajoy said on Wednesday forecasts would have to be revised as the new measures may have a negative impact on the economy in the short term before restoring growth.

Analysts believe the 2-1/2-year plan will be short-lived because it will not break the vicious circle of a recession prompting slippages in public finances which in turn trigger more austerity and depress the economy further.

"We doubt whether the envisaged €65-billion in fiscal savings will be realized in full," wrote the Dutch brokerage ING in a note after cutting its 2012 and 2013 economic forecasts.

The picture is made yet darker by the lack of access to international capital markets for the Spanish government, its banks and companies.

According to Bank of Spain data, capital is flying out of Spain at the fastest rate since records began in 1990.

However, European authorities, now seen as in partial control of the economy, say Spain should primarily reduce its high deficit in order to restore confidence and ensure financial stability.

"If you look at the size of Spanish deficit there can't be any doubt about the fact it needs to be brought down. It needs to be brought down in a limited number of years, I don't think you can regard this as shock therapy," said Thomas Wieser, the head of the group of euro zone senior officials who prepare the meetings of finance ministers.

The European Commission and the European Central Bank will closely monitor the implementation of the banking aid – which will be determined once and for all on July 20 – as well as the country's performance in reining in public debt and issue a report every three months, something analysts believe is setting the stage for a full-scale bailout.

Another question will be whether Spaniards accept deeper austerity, since one in four are already unemployed.

Civil servants said they could go on strike in September to protest the cuts but the government has so far been unmoved by protests, including those of miners from the northern regions of Asturias who marched more than 400 kilometres to demonstrate in Madrid this week.

That may change soon when Mr. Rajoy reforms the pension system, something that Brussels has repeatedly urged him to address although it would mean him breaking the last major campaign pledge that is still standing.

Mr. Rajoy said on Wednesday he would discuss with the Socialist opposition a change to the system based on EU recommendations to link benefits to life expectancy.

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