Viewpoint: Spain announces a new austerity budget to contain deficit

Lug 16, 2012

Minute Read

The Eurogroup has taken two small steps forward, but the ESM has taken a step back, following
the appeal to the German Constitutional Court. Spain announces a new austerity budget to contain deficit..….

For professional investors and advisers only

– After the ECB’s firm ruling out of the use of its securities purchase programme to stabilise the markets, the European authorities would be well advised to accelerate the procedures necessary for the functioning of what is already available (the EFSF) and would should be, but is still not (the ESM). At the European Council of 28-29 June, the possibility of using European funds to intervene on government bonds gained political consensus (and is also supported by the ECB President). On Monday, 9 July, a tiny step forward was made with the signing of a technical agreement between the ECB and the EFSF, that will allow the ECB to act on behalf of the EFSF on the secondary markets, presumably along the lines adopted in the past for the SMP. Another small step forward was made on the front of communication, as this time around the by-now traditional media sabotage of results for domestic policy ends by Northern European countries did not take place.

– On closer inspection, however, progress is still insufficient. The first problem is the incredibly limited margin of independence the German government can count on in taking decisions at the European level: the obligation to consult Parliament on each issue, and the frequent appeals to the Constitutional Court lengthen the decision-making process and introduce additional elements of uncertainty to procedures that are already sluggish. Another setback in this sense came this week, when the Constitutional Court declared the admissibility of the appeal filed against the ratification, already approved by a large parliamentary majority, of the two treaties (ESM and Fiscal Compact). Although rejection of the treaties is unlikely, at this point the risk is that the ESM will remain unavailable until September or October. In this case, the resources potentially available for interventions on the government bond market would be around 100 billion euros smaller than previously estimated.

– Even beyond this element of uncertainty, the size of the resources remains a problem for the medium term outlook. Relying on the EFSF alone, and subtracting the 30 billion that will be issued to Spain at the end of July, the residual amount is 213 billion euros (part of which, however, could be required to finance at least another tranche of the recapitalisation of Spanish banks, scheduled for November and estimated at 45 billion). On the one hand, this is unlikely to be enough to finance a mechanism aiming to significantly bringing down rates on Italian debt. On the other hand, it does seem adequate to at least integrate for a period of time demand flows on Italian debt (all considered, between August and December only 62 billion in BTPs and CCTs will reach maturity, part of which will be renewed by domestic investors). However, for the interventions to prove successful, no counterproductive conditions should be imposed, an aspect on which there are still no sufficient guarantees.

– Support in placing government bonds could also be useful for Spain, also challenged by serious fiscal consolidation issues that need to be resolved. The markedly negative trend of public finances in the opening months of 2012, and dependence on external aid for the recapitalisation of its banks (to be formally approved at the Eurogroup of 20 July), have forced the Rajoy government to announce an emergency austerity budget to achieve the new 6.3% public deficit target laid out for 2012 (vs. a previous target of 5.3%). Some measures, such as the VAT hike (three points for the ordinary rate, to 21%, and two points for the intermediate rate), will come into force in August; others (such as the “fourteenth month” bonus payment cut for public sector employees) later on in the year. The attempt to start a small fiscal devaluation by cutting social welfare contributions by one per cent should also be noted. The need to reduce financial leverage in the private sector, while at the same advancing a fiscal consolidation process, will represent a serious element of uncertainty clouding the trend of the Spanish economy in the years ahead.

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