After just four months in office, the new Spanish government faces a very difficult situation. The measures implemented by Mariano Rajoy’s administration have not been as effective as hoped. Spain is back in the headlines, becoming the key source of market turbulence in the minds of investors and financial analysts. Worst-case scenarios seem less and less remote.
Official authorities, such as the Finance Minister Luis de Guindos, have given assurances that Spain won’t need to be bailed out. However, financial markets are increasingly doubtful about the country’s capacity to fulfil its debt obligations. Following a few months of market tranquility, Spanish government debt yields, as well as credit-default swaps, have been soaring lately. In addition, the key stock-market index in Spain, Ibex-35, has performed very badly, both in absolute and relative terms.
Nonetheless, this market reaction shouldn’t come as a surprise - firstly, because the main reason behind the market tranquility of the previous months was the ECB intervention in November, the Long-Term Refinancing Operation (LTRO). This measure consisted of providing cheap three-year loans to troubled banks and buying the government securities of Spain and Italy, with the aim of lowering their borrowing costs. While the LTRO calmed markets, its effects, as recent events indicate, were only temporary.
Secondly, Spain’s economic problems have not been appropriately tackled by the Rajoy administration and remain as serious as before, if not more serious. (See my previous post on what needed to be done in Spain, 12 December 2011). For instance, although the approved labour market reform may be seen as a step in the right direction, is far from the deep liberalisation that is needed. The banking sector reform, on the other hand, postponed the day of reckoning without addressing the root of the problem.
In addition, the fiscal austerity path undertaken in the 2012 budget could be far more effective. It relies too much on tax hikes – increasing personal income taxand corporate income tax for big companies- and too little on spending cuts. As analysed elsewhere, the main responsibility with the Spanish budget deficit lies in the excessive spending growth of the last decade. Thus, most efforts should be focused on cutting spending. Fostering economic growth to increase public revenues, through market deregulation and the removal of barriers to entrepreneurship should also be a priority.
Moreover, the 2012 budget may miss the total government deficit target, given the sharp economic contraction and the likely conflicts arising from regional governments – where a good deal of responsibility to cut the deficit rests.
Unfortunately, the new government has not been able to foster market confidence in Spanish institutions. On the contrary, its policy path has been riddled with improvisation and inconsistencies, such as the revision of the new deficit target.
It can be deduced from the government’s actions that it lacks a well-thought out long-term strategy. Instead, it is acting with a short-term perspective. Most importantly, the government seems unwilling to transform the current rent-seeking economy into a freer, dynamic and competitive society. The complex web of interests and links between government and private agents, make it a very challenging process. The alternative, however, might be a forced and hard landing imposed by the Troika, with uncertain but surely disastrous consequences.
Ángel Martín Oro is the Director of the Economic Trends Reporter at the Instituto Juan de Mariana.