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Tags: EU | Spain

Spain Edges toward Economic Abyss amid Europe Woes

Wednesday, 28 March 2012 01:07 PM EDT

Investors concerned that Spain is fast becoming Europe's riskiest economic link and could be the next bailout candidate have plenty to worry about this week.

On Thursday, much of the country will shut down in a general strike against labor market reforms that make it cheaper for companies to fire and offers incentives for them to hire.

The next day, new center-right Prime Minister Mariano Rajoy is expected to unveil about €30 billion ($40 billion) in spending cuts and tax hikes in a deficit-slashing budget. This comes fast on the heels of a similar €15 billion austerity package unveiled less than three months ago as part of Spain's push to avoid joining the ranks of bailed-out Greece, Portugal and Ireland.

So far, Rajoy has only given hints about what's in store in the next round of fiscal pain for Spain, which is already lurching toward recession and is battered with an unemployment rate of nearly 23 percent, the highest among the 17 countries that use the euro.

But economists predict that government workers could face additional pay freezes or cuts, and that Spain's important regional governments may be forced to lay off temporary teachers and unveil reviled co-payments under which patients would pay part of the cost for national health care.

Infrastructure projects for new high-speed rail lines and highways are almost certain to be delayed, and higher taxes could be levied on corporations, tobacco and alcohol. Spain's military, already hit by huge debts, could see further cost cuts.

And while Rajoy has downplayed the idea of raising the country's 18 percent sales tax, experts don't rule out an increase.

All these measures are likely to cement predictions that the fourth-largest economy in the eurozone — behind Germany, France and Italy — won't grow start growing again until 2013.

Spain has already gone through successive rounds of cuts, tax hikes and deep fears that the country — reeling from the bursting of a massive property bubble — could be next in line for a bailout.

The country's economy is almost twice the size of the economies of Greece, Ireland and Portugal combined — sparking fears that its financial failure would send shockwaves throughout the region and the world's markets. More importantly, financial troubles in Spain would likely trigger a run on Italy and could ultimately lead to a breakup of the currency union.

"If you put Spain in danger, Italy is in danger and maybe even France," said Antonio Barroso, an London-based analyst with the Eurasia Group consulting firm.

Fears over Spain's future grew more intense in February when Rajoy's conservative Popular Party, which ousted the left-of-center Socialists in November, revealed that the country's 2011 deficit came in at 8.5 percent of economic output — far above an earlier 6 percent estimate.

Rajoy had already imposed a new round of tax hikes and budget cuts seen as crucial for the country's economic health, but he then went on to unnerve investors and European leaders by proclaiming his government would miss this year's deficit target.

Instead of sticking to a deficit target of 4.4 percent of its gross domestic product in 2012, one that had been promised to the European Union by the Socialists, Rajoy declared he would instead aim for 5.8 percent, while still pledging to bring it down to 3 percent in 2013.

Rajoy's unilateral move did not go down well in Brussels, home to the European Commission that sets the financial rules for eurozone members.

In a lighthearted reflection of the EU's frustrations, Spain's economy minister, Luis de Guindos, at a recent meeting was photographed being jokingly strangled by Luxembourg Prime Minister Jean-Claude Juncker, who also chairs the regular get-togethers of the currency union's finance ministers.

The Commission argues that countries that use the euro must slash high deficits to convince investors that the currency union can overcome a more than two-year-old debt crisis.

Spain and the EU have since agreed on a new 2012 target of 5.3 percent of GDP, but doubts that the government can actually meet even this easier target pushed the country's borrowing costs higher on financial markets in the following days.

Italy's premier, Mario Monti, fed the concerns last weekend when he told business leaders that Spain "is giving the EU concern because the interest rates have risen, and it doesn't take much to re-create contagion that could spread" to the rest of Europe.

Spain is essentially caught in a vice. Some investors and European leaders question whether Spain is committed enough to fiscal responsibility and will follow through with its commitments to remain a member in good standing in the eurozone.

Others worry that overly hasty cuts in a country that used to one of the continent's top fiscal performers will further batter an economy whose downfall was largely triggered by the collapsing real-estate boom.

The origins of Spain's troubles can be traced to the euro's creation more than a decade ago. The new currency not only brought down interest rates even in countries that had previously been seen as more risky, but also sent billions of euros in outside investments to booming economies like Spain. Spanish companies and families binged on cheap loans, which fueled a real-estate boom that came to dominate the economy.

The global credit crunch of 2008 burst Spain's property bubble, triggering a steady rise in unemployment, and reducing government spending will likely put more people out of work, forcing them to fall behind on their mortgages.

That, in turn, could leave Spain's struggling banks with even bigger bad loan burdens and toxic property assets and push them to seek financial assistance from the state. Some economists fear that further bank bailouts could drive up Spain's debt much faster than a few years of higher government deficits.

Complicating the picture is the political risk of how angry Spaniards will get about rising unemployment — which is already forcing many to seek jobs abroad.

Thursday's general strike will be seen as a key measure of Spanish discontent, and young Spaniards under 25 who face joblessness of nearly 50 percent are expected to turn out in force.

Spain saw an unprecedented outcry last year among young "indignados" ("indignants" in English), and several protests this year over education cuts have turned violent after the groups clashed with police.

The sheer scope of the anticipated cuts and the recent labor reforms are expected to push the unemployment rate beyond 25 percent, putting Spain's economy at risk of sputtering or contracting for an extended period, economists say.

"There is a risk of greater economic depression and a drop in revenue, but it is true that you have to correct public spending and get rid of some inefficient parts, even though that involves layoffs," said Juan Carlos Martinez, an economics professor with Madrid's IE Business School.

Many Spanish companies had been holding off from shedding workers until the labor reforms were passed last month, and will probably soon start letting employees go, said Gayle Allard, an economist who specializes in labor market issues.

Spaniards themselves will probably see their vast social welfare systems cut back hard — especially at the local level, said Antonio Moreno, an economics professor at the University of Navarra.

The regional governments that function like U.S. states control education and health care funding, their biggest expenses. Some regions may follow the lead of northeastern Catalonia, which recently started charging residents part of the cost of prescription medicine.

Spanish governments are prohibited by law from laying off public servants, but schools rely heavily on temporary teachers — some of who have already lost their jobs with many more at risk of being targeted, Moreno said.

While Rajoy said this week federal government ministries will face budget cuts of about 14 percent, Moreno doubted that the prime minister would do away with any of his ministries. However, he said the government could close down underused airports, and a massive freeze on most infrastructure projects is almost guaranteed.

Other measures recently floated by the regions include increased fees for masters degrees and making college tuition more expensive for students who choose to pursue higher education outside their home regions.

"We're going to see things happening in health and education in reducing the services and increasing some of the costs," Moreno said. "You have to get those millions of euros somewhere. It's a very straightforward way to do it, but it hurts the economy by hurting consumption."

© Copyright 2022 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

Wednesday, 28 March 2012 01:07 PM
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