Updated 10:39 am, September 28, 2012
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By Tony Connelly, Europe Editor, in Madrid
Now that the Spanish budget has been presented we should know more about when the government of Mariano Rajoy will move into full bailout mode.
The centre-right prime minister has delayed long and hard before seeking a rescue, but the European Commission has warned that it is a dangerous game which could deepen the country’s economic woes, and stop the fragile sense of eurozone optimism in its tracks.
As part of an elaborate process choreographed by ECB president Mario Draghi, once Spain seeks formal help from the European Stability Mechanism the ECB can then intervene in a massive and unlimited way in the secondary bond market in order to lower Spain’s borrowing costs.
Spain can go for what are called “precautionary credit lines” or can ask the ESM to buy its bonds in the primary market.
However, the intervention by the so-called Creditor Bloc – Germany, the Netherlands, Finland and Austria – on how the ESM should be constrained from taking on “legacy” debt has cast the process into confusion.
It remains to be seen if these countries will be dogmatic in preventing the ESM from being used to recapitalise banks in Ireland and Spain for debts incurred during their respective property booms, or whether a compromise will be reached at eurozone finance minister – or even heads of government – level.
However already the blend of violent street protests, and confusion over the ESM and its true function, has pushed Spanish ten-year borrowing costs back above 6%.
Will Rajoy now move?
Observers have made much of Mr Rajoy’s stubborn Galician temperament, and his predilection for waiting as long as possible before making a decision.
Even though he was elected with a large majority last November, he preferred to wait until after the Andalusian regional poll in March before announcing his first budget.
That strategy backfired dramatically: the Partido Popular lost the election, and Mr Rajoy lost credibility in the eyes of his eurozone partners.
This week’s budget was the fourth austerity package since Mr Rajoy took office. His deputy prime minister Soraya Saenz de Santamaria presented the budget as a social pact, given that 65% will go on social welfare spending.
However, with unemployment at 25%, that ratio is more by necessity than ideological instinct.
Income tax will increase, but tax on labour will remain untouched. There will be a new 20% tax on lottery wins, and further incentives to boost car sales.
The government has stuck to its pledge not to reduce pensions, but any index-linked increase in pensions will be paid for through the national pension reserve fund.
Sound familiar? The Spanish budget is very similar to what Ireland had to do as part of our bailout programme.
The fact that Spain is also setting up an independent fiscal advisory council shows that the fingerprints of the European Commission are all over this budget.
Indeed, the Commission has acted as midwife to the plan in order to allow Mr Rajoy to show voters and investors that this is a “home-grown” budget. In other words, if Madrid goes for an EU bailout it may be spared a full-blooded memorandum of understanding since most of the reforms and cuts are already in place.
This means that Mr Rajoy now has one less political excuse for delaying the request much further.
However some observers suspect that Mr Rajoy will still hedge, even to the extent that he wants Italy to seek help first and thus preserve Spanish pride.
“He could be waiting for Italy to move before he moves,” said Professor Fernando Villespan of the Jose Ortega Y Gasset Foundation in Madrid.
“I think it’s a dangerous strategy because it doesn’t help him internally either. Of course we have local elections in Galicia and the Basque Country, but that’s not a reason for not moving.”
The uncertainty does not help the Irish government either.
Spain has been offered up to â‚¬100 billion in eurozone support for its banking sector. That money will be disbursed through a government vehicle known as FROB, and the funds will be counted as part of the country’s overall debt and deficit levels.
However according to the statement issued by eurozone heads of government at that all-night summit on 28 June, the ESM can in future be used to recapitalise banks directly so that the burden is not shifted on to the sovereign.
Although the statement this week by the aforementioned Creditor Bloc has muddied the waters further, Dublin had been anxious for Spain to move on its bank debt so that the way might be clear for it to do the same with its own.
Furthermore, so long as uncertainty remains around Spain’s ability to turn its economy around, especially given its spectacularly high unemployment levels, investors will continue to expect a higher yield for buying Spanish bonds.
There is also the persistent fear that the government’s plan to cut spending during a recession will force Spain into a self-defeating spiral.
“There are big uncertainties around the impact of introducing the kind of austerity Spain has been doing,” said Daragh Quinn, an analyst with the brokerage firm Nomura.
“They have to reach a 3% budget deficit to GDP level by 2014. This year the deficit is supposed to be 6.3%, but a lot of economists are forecasting it to be closer to 7%.
“To try and take that much out of GDP with an over-leveraged private sector when you’re in a recession… it’s difficult to find countries who have achieved that in the past. Examples we’ve seen, like Portugal, show it’s very difficult to do that in a recession.”
Meanwhile unemployed yet well-educated young people continue to leave Spain in large numbers, either for Britain, the US or, more frequently, Latin America.
Estela Lopez is a 29-year-old TV journalist with five years of third level education under her belt, including an MA in International Relations. Yet the most she can manage is short-term and piecemeal freelance work.
“I don’t think I can stay in Spain right now because there’s huge unemployment among young people and it’s very difficult to get a job,” she said.
“We have our illusions and our dreams, but we cannot realise them in Spain.”