Spain: Public Deficit Could Hit 12% in 2009
July 9th, 2009
Spain’s fiscal austerity drive is being met with scepticism by economists, who fear it will be unable to cut spending as it struggles with potential bank bailout costs and a persistent recession.
This means the country could find borrowing increasingly expensive, despite its new-found zeal for spending controls.
Having had its sovereign credit rating downgraded once during the crisis, the government is keen to avoid further cuts that would increase debt risk premiums.
In the last month, Spain has hiked tobacco and fuel levies, flagged more tax increases in 2010 and proposed axing spending to stop its budget deficit entering double digits.
But one person with access to public accounts, who asked not to be named, told Reuters the public deficit could more than triple to 12 percent this year from 3.8 percent in 2008.
Spain entered the crisis with some of the healthiest public accounts in Europe, but must absorb the twin shocks of its deficit and a 99 billion euro ($139.3 billion) bank rescue fund.
Economists fear the government could face expensive bank bailouts in 2010 as a prolonged recession, and possible interest rate hikes, make it impossible to cut the budget deficit.
“If all that comes together, then people really don’t want to hold Spanish debt,” said Ben May at Capital Economics.
Spain has suffered the worst deterioration in public finances of any EU country, bar Ireland, after stimulus measures equal to 4.2 percent of gross domestic product in 2008 and 2009.
The spending is aimed at containing unemployment that has risen faster than in any other EU member due to the global crisis and a domestic, Spanish property crash.
UBS says Spanish non-performing loans could double to more than 9 percent of outstanding credit in 2010, based on its forecast that unemployment will reach 25 percent.
The investment bank expects Spanish savings banks to need 112 billion euros in capital to restructure.
Even without borrowing to cover bank bailouts, Spain is expected to swell public debt 23 percentage points to 62.3 percent of GDP by 2010 — the biggest leap in any euro zone member except Ireland, the European Commission forecasts.
Up to now, the relative health of Spain’s financial system and fiscal accounts have contained the spread on its 10-year bond, which peaked at 128 basis points in mid February against benchmark German debt and has now fallen to 75 points.
But now markets are eyeing future risks and credible fiscal stimulus exit strategies, said BNP economist Dominic Bryant.
He is concerned that Spain is proposing fiscal tightening in some areas to continue expansive policies in others, such as higher unemployment benefit spending.
“Will their actions dramatically reduce the deficit in the next year or two? The answer is no,” said Bryant. “The ratings agencies will be waiting to see what success the policies have.”
Agencies have warned sovereign lenders they risk downgrades unless debt and deficits are cut over the medium term.
Ben May said Spain could suffer the same fate as Ireland, another former euro zone high flyer, forced to slash spending and hike taxes after government exposure to bank liabilities and housing-market revenues led to rating cuts.
Socialist Prime Minister Jose Luis Rodriguez Zapatero hopes emergency spending will bring recovery in the first quarter of 2010. The EU expects Spain to be the last of its 27 members to exit recession, probably in 2011.
“What we’re seeing is that the supposed rapid recovery isn’t going to happen,” said Citi strategist Jose Luis Martinez.
Worse, the lack of coordination between fiscal and monetary policy in the 16-member euro zone could mean the ECB hikes rates in the second half of 2010, just as Spain is forced to cut spending at a time when its economy could still be struggling.
The government, which has long downplayed the seriousness of the recession, has begun to show signs of economic realism.
Finance minister Elena Salgado on June 12 forecast no annual growth until 2011 and unveiled the first in an expected string of tax hikes.
The government may cut a third of stimulus spending in 2010 to keep the deficit in single figures and show its commitment to steering the deficit toward an EU limit of 3 percent in 2012, the Cinco Dias newspaper reported.
“The Spanish government doesn’t have a choice: some fiscal tightening will have to be implemented at some point in the future,” said UBS in a recent research note on Spain.
Ultimately, it will be agencies like Standard & Poor’s and Moody’s that decide whether Spain can contain credit risk. Credit default and public debt spreads will give early warnings.
“It’s a big risk the market places more weight on risks than looking at the starting point of public finances,” said May.
Story from The Guardian
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