Summer is over as Spain adapts to life outside its bank bailout programme

Spain's first day outside its EU-IMF bank bailout programme started with the publication of the new data on unemployment from the country's national statistics institute (INE). As we predicted on this blog last year (see here and here), the figures after the end of the summer - when a lot more seasonal jobs are on offer - look less encouraging than in the previous two quarters.

Let's start with the headline figures. In the last quarter of 2013, the general unemployment rate increased slightly from the previous quarter - from 25.98% to 26.03%. This means that, at the end of last year, 5,896,300 people in Spain were out of work.

It's worth looking at the figures a bit more in detail:

• The number of unemployed people went down by 8,400 in the fourth quarter of 2013, and by 69,000 in the year as a whole. This is positive, but has to be weighed against a significant fall in the economically active population - those working or actively looking for a job.

• Spain's active population decreased by 73,400 in the last quarter of 2013 alone, and by 267,900 in the year as a whole. As a result, the active population is now 59.43% of the total - the lowest level since the first quarter of 2008. The upshot of this is that, while the number of unemployed people may fall, a lot are simply switching to being economically inactive.

• The number of employed people went down, both in the fourth quarter of 2013 (-65,000 from Q3) and in the year as a whole (-198,900). However, it has to be said that the decline is less sharp than in the previous years.

• On a more positive note, the seasonally adjusted employment rate went up slightly (0.29%) in the fourth quarter of 2013, and it's the first time it happens since the first quarter of 2008. Similarly, the seasonally adjusted unemployment rate decreased by 1.22% from Q3. Again, though, this has to be put into perspective - notably with the reduction in the economically active population.

• One of the most concerning points comes with the level of long-term unemployment, which towards the end of last year reached new record highs. Over 13% of the active population have now been unemployed for twelve months or more (click on the graph below to enlarge). The knock-on effects of this are significant. It is well proven that the longer people are unemployed for, the harder it is for them to find work. It also diminishes their skill level and hampers future earning potential. This is worsened by the fact that, in Spain, many of these are likely to be younger workers.

The latest unemployment figures show that, despite some encouraging signals, it will still take time before Spanish citizens feel the recovery has started. It also means the Spanish government may consider a second round of reforms - perhaps more targeted at closing the gap between the education system and the needs of the labour market.   

What's the best place to publish an ECB letter setting out your country's economic policies?

Former Spanish Socialist Prime Minister José Luis Rodríguez Zapatero has upset quite a few people after he included the letter he received from the ECB and the Bank of Spain in August 2011 in his recently published memoirs. Though bits and pieces of the letter had already been disclosed, the full content was never really made public. In a radio interview today, Zapatero has justified his decision to keep the content of the message secret at the time because at least part of it "would have put stability at risk".

Courtesy of El País, we have had a look at the letter – and we thought it was worth translating a few key points:

• The first priority identified by the ECB and the Bank of Spain is labour market reform. The letter reads, “We deem it necessary to adopt additional measures that improve the functioning of the labour market […] We are enormously concerned about the fact that the [Spanish] government has not adopted any measure to abolish inflation-indexing clauses. Such clauses are not an appropriate element for the labour markets in a monetary union, as they represent a structural obstacle to the adjustment of labour costs.” 

• The letter goes on, “The government should also adopt exceptional measures to promote wage moderation in the private sector [...] We suggest revising other labour market regulations shortly, with a view at speeding up the re-integration of unemployed people in the labour market [...] We see important advantages in the adoption of a new exceptional work contract that is applied for a limited period of time, and where compensation for dismissal is very low.” 

• The second priority is the adoption of “bold measures to ensure the sustainability of public finances. The government should prove in a clear manner, by action, its unconditional commitment to the achievement of its fiscal policy targets, irrespective of the economic situation. To this end, we urge the government to announce, by the end of this month, additional measures of structural fiscal consolidation for the remainder of 2011 worth at least more than 0.5% of GDP.” “Simultaneously”, continues the text, “the application of national fiscal norms must be continued in order to ensure [central] control over regional and local budgets (including the authorisation for debt emissions by regional governments).” 

• The third priority is product market reform. According to the letter, the Spanish government should “increase the competitiveness of the energy sector in order for prices to better reflect the cost of energy” and “increase the competitiveness of the services sector, in particular by addressing the regulation of professional services.” 

Therefore, as in the case of Italy (see our blog post from September 2011), the letter was a lot more than just a push to shape up. It was a detailed and quite prescriptive to-do list in return for ECB bond-buying - even boiling down to specific policy measures and the size of fiscal cuts. Furthermore, it did not shy away from touching on politically sensitive issues for Spain – just think of the demand for more central control over regional spending or the abolition of wage indexation.

All this put the ECB squarely in the realm of domestic fiscal policy, somewhere many would agree it should not be. In any case, any country considering applying for an OMT bond-buying programme should consider these points when wondering how prescriptive the conditionality might be.

The closing paragraph of the letter sounds a lot like a warning. It reads, “We are confident that the [Spanish] government is aware of its highest responsibility in the good functioning of the eurozone in the current [economic] conjunction, and that it will adopt in a decisive manner the necessary measures to regain the confidence of the markets in the sustainability of its policies. Such measures […] should greatly benefit not only the Spanish economy, but also the eurozone as a whole.”

Therefore, it is no surprise that many of the letter’s ‘suggestions’ have become government policy – though under the centre-right cabinet led by Mariano Rajoy, who took office at the end of 2011.

Slush fund scandal reignites in Spain, but risk of early elections remains small

UPDATE (16:00): Another interesting fact from the Rajoy-Tusk presser. When a foreign leader comes to Spain on an official visit, the protocol establishes that, at the joint press conference, Spanish journalists and their counterparts from the visitor's country are only allowed two questions each.

Today, it had been agreed that the two questions from the Spanish side would come from El Mundo and the news agency EFE. However, Rajoy unexpectedly gave the floor to a journalist from ABC.

Asked by his colleagues at the end of the presser, the ABC journalist explained that he had received a phone call from his editor dictating him the exact wording of the question he had to put to Rajoy - who then replied by reading a short written statement he had prepared.

UPDATE (15:00): At the joint press conference with his Polish counterpart Donald Tusk, Spanish Prime Minister Mariano Rajoy said, "I'm going to fulfill the mandate I was given by the Spaniards" - a clear indication that he's not planning to resign.

Meanwhile, the first details from Mr Bárcenas's court hearing are emerging. For the first time, he admitted that he was indeed the author of the 'parallel' accounting books published by El País earlier this year (see our blog from last January for further details). Mr Bárcenas reportedly also declared that he made cash payments to Rajoy himself and María Dolores de Cospedal, the Secretary General of Partido Popular, in 2008, 2009 and as recently as March 2010. 

OUR ORIGINAL BLOG POST (11:30)

Remember the slush fund scandal that broke out earlier this year in Spain? Prime Minister Mariano Rajoy and other senior members of the ruling Partido Popular allegedly received illegal cash payments from the party's former treasurer, Luis Bárcenas (in the picture). All these payments were registered in 'parallel' accounting books that were leaked to the Spanish press (see our blog from last January for further details).

After a couple of months of relative calm, the scandal is now reigniting. El Mundo yesterday published several screenshots from Mr Bárcenas's mobile, allegedly showing that Rajoy sent him supportive text messages after the scandal was exposed - the most recent one in March - and asked him to keep calm and deny the existence of the secret accounting books.

Unsurprisingly, the opposition Socialist Party has called for Rajoy to resign "immediately" in light of the latest revelations. Equally unsurprisingly, Rajoy's office denies any wrongdoing and accuses Mr Bárcenas of trying to "deviate attention" from his own judicial problems.

So what happens next? The following points are worth keeping in mind:

• Partido Popular holds an absolute majority in the Spanish parliament, so it looks quite hard for the opposition to force Rajoy out. Indeed, the Spanish Prime Minister could still choose to step down voluntarily or be forced to do so by his own party - but neither option seems to be on the table at the moment;

• Even if Rajoy resigned, he would have the right to indicate his successor - and the King of Spain would have to appoint this person as the new Prime Minister until the end of the current parliamentary term;

• Crucially, the Socialist Party itself has made no mention of early elections so far. They simply want Rajoy to quit and be replaced by someone else from his party. An understandable position, given how badly the Socialist Party is doing in the latest opinion polls.

Therefore, the risk of snap elections remains small for now - although the scandal will inevitably cast a shadow over Rajoy's government, at least until things become clearer.

Today, all eyes in Spain will be on two key events: Mr Bárcenas is due to appear in court, and is expected to provide some more details about the latest events. To add a further twist to the story, his lawyer yesterday said Mr Bárcenas didn't know anything about the publication of his exchange of text messages with Rajoy by El Mundo.

The Spanish Prime Minister is also due to speak in public, in a joint press conference with his Polish counterpart Donald Tusk - which is also going to be interesting. We will keep a close eye on anything coming from Spain throughout the day, so keep following us on Twitter @OpenEurope and @LondonerVince.

Spain's credibility suffers another blow as Eurostat spots some creative accounting

Two weeks ago, we noted on our blog that the Spanish Tax Agency had delayed around €5bn of tax refunds (due in December 2012) deferring payments to January 2013 instead. This contributed to Spain missing its EU-mandated 2012 deficit target (6.74% of GDP, instead of 6.3% of GDP).

We wondered whether the sudden increase in tax refunds (up by 82.8% in January 2013 compared to previous year) would not lead the European Commission to start asking some question. Sure enough.

The EU's statistics office Eurostat has asked Spain to raise its 2012 deficit to 6.98% arguing that Spain was not correctly accounting for tax refunds. Basically, Eurostat rules say tax refunds have to be counted towards the deficit when they are claimed by taxpayers. Spain only includes them when they are paid out.

This means Spain will have to retroactively revise its deficit figures, going all the way back all to 1995. The difference for 2012 in itself is not huge. And Spain remains unlikely to face sanctions, as the European Commission has now shifted its focus to 'structural' deficit, but not inspiring confidence.

In an official note published yesterday, the Spanish Budget Ministry tried to blame Eurostat for the revision of the deficit figure, saying it was due to a methodological change "demanded by Eurostat over the past few days".

But according to a spokeswoman for EU Tax Commissioner Algirdas Semeta quoted by Expansión,

"Eurostat hasn’t changed its methodology or its rules. It has simply found out that the methodology used by Spain was incorrect."

Eurostat has realised this only now because,

"The [spending] pattern suddenly changed…when Spain moved to January 2013 certain payments due in December 2012." 

Eurostat will publish its final deficit figures on 22 April. Spanish Budget Minister Cristóbal Montoro said this month that, if anything, the 2012 deficit figure of 6.74% of GDP would have been revised downwards. He's been proved wrong once. He can only hope it doesn't happen again.  

Is Spain using accounting tricks?

This is interesting from today's El País. The paper suggests that the Spanish government could have decided to delay various tax refunds due in December 2012 and pay them in January 2013 instead, in order to close the year with a lower deficit figure.

These refunds (around €5 billion in total) would have affected revenue from VAT and income tax, both individual and corporate. Had they been paid out in December, Spain's public deficit at the end of last year would have been around 7.2% of GDP. The target agreed with the European Commission was set at 6.3% of GDP.

El País notes that data from Spain's Agencia Tributaria (tax agency) show that tax refunds in January 2013 were 82.8% higher than in January 2012 (see the table on page 15). This seems to indicate that the Spanish government may have deliberately pushed back the refunds to send a lower 2012 deficit figure to Brussels.

The Spanish Treasury Ministry has denied the reports and given its own version. Basically, due to recent legislative changes, tax refund applications need to be looked through "with greater attention" - and stricter controls take longer. No accounting tricks are being used.

Both versions sound plausible. We would note, though, that even if the Spanish government did dodge including the refunds in last year's deficit, it will certainly have to factor them into this year's deficit. Not exactly a permanent fix, although we have seen very similar one-off measures used in Portugal to meet deficit targets (see, for instance, this post we wrote in November 2011).

With that in mind, we can't help but wonder whether the European Commission will want to know more details about this story, although Olli Rehn & co. seem to be more focused on structural deficit for now.  

Spain's slush fund scandal: This is not going away soon

New interesting details have emerged on the slush fund allegations involving Spanish Prime Minister Mariano Rajoy and his Partido Popular (PP). The party has said that it will take El País to court, because the 'secret' accounting books allegedly held by PP's former treasurer Luis Bárcenas are fake. However, the paper today reports that a couple of senior members of Rajoy's party have admitted that they did receive the payments registered in the books under their names.

A spokesperson for Pío García Escudero, the speaker of the Spanish Senate, said that Escudero actually asked the party for a 5 million pesetas (some €30,000) loan in 2000. He needed the money to repair his house in Madrid, which had been destroyed by an attack from Basque terrorist group ETA. Escudero says he paid the loan back in instalments of 1 million pesetas each, and stresses that he never dealt with Bárcenas personally.

Similarly, people close to Jaume Matas - a former Environment Minister and President of the Balearic Islands region - have confirmed that the party agreed to pay him some sort of 'transition allowance' between when he quit the cabinet and when he became PP's candidate for President of the Balearic Islands. Now, El País notes that Matas stepped down as Environment Minister in March 2003 and was elected as President of the Balearic Islands in May 2003. Perhaps just a coincidence, but the €8,400 payment to Matas is dated 2 April 2003 in the books.

Interestingly, during her press conference yesterday, the Secretary General of PP María Dolores de Cospedal (pictured) was asked about Escudero's admission. She said that specific payment "may be true", but this does not automatically validate the documents, because "some people ask for money in advance, this happens in all companies. It's no extra pay." Not an entirely convincing answer.

One last aspect is worth flagging up. El País stresses that, according to the Spanish law on the financing of political parties in force from 1987 to 2007, donations larger than 10 million pesetas (around €60,000) were forbidden. Therefore, 70% of the donations disclosed by the paper would have been illegal at the time when they were made - potentially quite a strong incentive to try and hide them in 'parallel' accounting books. 

Rajoy has convened a meeting of top members of his party, scheduled for tomorrow - but has yet to announce when (and if) he will speak to the press on this issue. Meanwhile, hundreds of Spaniards protested outside his party's headquarters in Madrid yesterday and called for him and his cabinet to resign immediately. This story is getting increasingly interesting, and is not going away anytime soon.  

Looking to the New Year?

With trouble flaring up in Greece once more and the backstop of the ECB’s bond-buying (OMT) in place, Spain has slipped off the radar slightly. It now seems likely that any request for a sovereign bailout (of one form or another) will be pushed back until the New Year.

However, interestingly, Spain returned to the debt markets this week despite having its funding costs covered this year. It successfully sold almost €5bn worth of short-term debt on Tuesday and almost €3.9bn of medium and long-term debt yesterday.

This could mean many things, not least that the Spanish government is concerned about its cash position or the potential for unexpected costs (a regional or bank bailout for example), but we’re willing to give Spain the benefit of the doubt and see it as prudent planning to get a head start in covering its funding needs next year. This comes as somewhat of a relief given that gross Spanish funding needs could run between €150bn and €200bn next year.

On a separate, and slightly less positive note, the European Commission has, in a working document, questioned why the Spanish government has, in substance, refrained from intervening in those Spanish regions which are "clearly at risk of missing their fiscal targets in 2012" - despite legislating earlier this year to give itself such power? It is an interesting question, we would hazard a guess that the Spanish government is not ready to face the political consequences of such an action.

We can’t exactly blame them on this front but it raises the question of where their threshold is and what the repercussion of such an action would be.

As per usual from Spain then, a bit of a mixed bag, but at least it seems to be planning for next year. Now if only it took a longer term approach to its banking sector and labour market reforms…

Some more (draft) bad news for the Spanish government

The European Commission is due to unveil its autumn economic forecasts on Friday, but El País has already seen a draft of what the Spanish government is going to be told - and, unsurprisingly, there seems to be no good news coming from Brussels.

First off, the Commission is going to confirm that the growth forecasts used by the Spanish government to table its budget for next year were overly optimistic. According to the Commission, the Spanish economy will contract by 1.5% of GDP next year - three times higher than the 0.5% the Spanish government was betting on (or maybe we should say 'hoping for'?). Incidentally, we also flagged up this weakness in the Spanish budget for 2013 when it was presented at the end of September (see here).

Unfortunately for Mariano Rajoy and his cabinet, though, the bad news does not end there. The draft seen by El País also shows that Spain is set to miss all the deficit targets agreed with Brussels until 2014 - and not exactly by a whisker. Worryingly, the Commission believes Spain's deficit at the end of 2014 will be 5.8% of GDP - with the target set at 2.8%. In other words, Spain looks set to fail to bring its deficit below the threshold of 3% of GDP enshrined in the EU Treaties, even after being granted an extra year to do so.

If confirmed, the Commission's forecasts will deal another blow to the credibility of the Spanish government - not least because Madrid decided to stick to outdated growth predictions to table its budget for next year, despite the IMF and others clearly warning that the recession was going to be much worse.

The official figures will be out on Friday - and we will post a more comprehensive analysis then.

Given all this then, it is a slightly ironic day for Spanish Finance Minister Luis de Guindos to publish an op-ed in the WSJ under the headline, "Spain's future is bright. Nobody in the international arena doubts the bold determination of the Spanish government." These figures suggest differently, and we expect Spain could find an increasingly impatient audience at meetings with other eurozone countries, especially after its decision to block the appointment of Luxembourg's Yves Mersch to the ECB's Executive Board.

Spanish regional elections: Why the victory for Rajoy's party in Galicia should not be overplayed

Following the latest round of regional elections in Spain on Sunday, the foreign media clearly seem to have focused their attention on the victory of Spanish Prime Minister Mariano Rajoy's Partido Popular (PP) in Galicia (see, among others, this article from today's FT). Of course, the fact that outgoing Galician President and PP candidate Alberto Núñez Feijóo (pictured with Rajoy) has not only confirmed his absolute majority, but also managed to consolidate it by winning three more seats than he had during his previous term is remarkable, given the nationwide drop in the party's popularity.

However, the significance of the victory in Galicia should not be exaggerated, for a number of reasons. Firstly, Rajoy is Galician. Although, as noted by the Spanish press, he avoided appearing next to Feijóo during most of the electoral campaign, Rajoy did travel quite a lot across the region - and it would be naïve to think that his personal involvement did not win Feijóo a few extra votes.

Secondly, Galicia is a region with solid right-wing credentials. The region has been governed by centre-right forces for much of the time since Spain returned to democracy - including fifteen consecutive years between 1990 and 2005 under Manuel Fraga Iribarne, a former minister under Francisco Franco (a Galician native himself) and the founder of Alianza Popular in 1976, which became Partido Popular in 1989.

Therefore, we definitely think the results of the Basque elections were far more interesting - for one very simple reason. Unlike after the previous elections in 2009, Rajoy's Partido Popular and the opposition Socialist party together do not command a sufficient majority to stop the candidate of the Basque Nationalist Party (PNV) Íñigo Urkullu becoming the region's new President - although he will need the support of other parties to secure a majority in the Basque parliament.

It is not unusual for nationalist parties to be in government in the Basque Country, but the context looks quite different this time. During the electoral campaign, Urkullu has clearly said that he wants to make the Basque Country a "European nation". The expression must sound worryingly familiar to Rajoy and his cabinet, as it clearly echoes Catalan President Artur Mas's recent calls for Catalonia to become "a normal nation within Europe".

Incidentally, a new Feedback poll for Catalan TV channel RAC1 this morning credited Mas’s party with 67 seats in the 25 November regional elections – only one seat short of an absolute majority in the Catalan parliament. The same poll also found that over 70% of Catalans are in favour of pushing ahead with plans for a referendum on the relationship between Spain and Catalonia, even if the Spanish government prohibits it.

The Catalan elections are yet to take place, but there is clearly the potential for a major 'sovereigntist' headache here - and at a time when the Spanish government can least afford it.

Spanish regions: We hate to say 'We told you so', but...

In July, we published a briefing looking at the potential impact of regional debt problems on the Spanish economy. In particular, we noted that Spanish regions were expected to make swingeing cuts to meet the overly ambitious regional deficit target of 1.5% of GDP by the end of the year. Based on the size of cuts each region had agreed on with the Spanish government, we drew the 'traffic light' table below:

Three months later, it's time for an update. Following today's bailout requests from the Balearic Islands and Asturias, eight of 17 Spanish regions have decided to tap the €18 billion bailout fund set up by the Spanish government. And guess what? Four of them (Castilla-La Mancha, Comunidad Valenciana, Murcia and the Balearic Islands) are in the 'red' area of our table - i.e. among the regions that, according to us, had agreed to unattainable deficit reduction targets for this year. Catalonia, Asturias and Andalusia - top three in the 'amber' area - have also sought help from Madrid. To date, Canary Islands are the only surprise, as they have requested a bailout despite having to make the smallest deficit adjustment of all Spanish regions.

With only less than half of regions covered (although, of course, not all of them will need financial assistance), the Spanish government's bailout fund for regions (which totals €18 billion) has almost run out of money. Here is what each region has requested:

Catalonia: €5.4 billion
Andalusia: €4.9 billion
Comunidad Valenciana: €3.5-4.5 billion 
Castilla-La Mancha: €848 million
Murcia: €641 million
Canary Islands: €757 million
Balearic Islands: €355 million
Asturias: €262 million

TOTAL: €16.7-17.7 billion

So, if all regions obtained the entire amount they have asked for, there would be almost no money left in the pot - and two more regions in the 'red' area which may well need assistance (the case of Galicia is slightly different, as we explained in our briefing). This is why the Spanish government is trying to hold off on at least part of the loans. It has, for example, agreed to lend Andalusia only €2.1 billion, and €2.5 billion to Comunidad Valenciana - for the moment. However, regional governments will presumably push to get all the money they asked for - which in turn increases the likelihood that the bailout fund will need a top up.

We remain of the view that regional debt problems will not 'make or break' Spain financially, although depending on how the payments are handled they may increase Spain's deficit - as will the fact that the regions are still likely to miss their targets for this year. In any case, though, in the eyes of Spain's eurozone partners and the European Commission, every additional region tapping the bailout fund adds to the impression that the Spanish government is simply not capable of keeping regional spending under control. For once, we agree with the EU/IMF/ECB Troika on something.

Some preliminary thoughts on the stress tests for Spanish banks: lots of optimistic assumptions...

Here is the full report (and the bank-by-bank results) from the latest Spanish bank stress test exercise. Below we provide the key points and our initial thoughts on them.

The tests put the total capital needs of Spanish banks at €59.3bn, but Spanish Deputy Finance Minister Fernando Jiménez Latorre (in the picture) just told journalists during the press conference that, assuming that Spanish banks manage to raise part of the money from other sources, the Spanish government could ask the EFSF for "around €40bn" (as we anticipated here).

Key points: 

• 14 banks assessed, 7 found to be well capitalised, 7 found to need capital injection. Total needs put at €59.3bn. This falls to €53.75bn when the mergers under way and the tax effects are considered;

• €24.7bn of the total amount is earmarked for Bankia alone, with a further €10.8bn for CatalunyaCaixa and €7.2bn for NovaGalicia;

• The adverse economic scenario assessed was: 6.5% cumulative GDP drop, unemployment reaching 27.2% and additional drops in house and land price indices of 25% and 60% respectively, for the three-year period from 2012 to 2014;

• Cumulative credit losses for the in-scope domestic back book of lending assets are approximately €270bn for the adverse (stress) scenario, of which €265bn correspond to the existing book. This compares with cumulative credit losses amounting to approximately €183bn under the base scenario.

Open Europe take: 

• The base case scenario seems overly optimistic, the adverse scenario looks more realistic - although we expect a fall in house prices of around 35% rather than the 25% assumed. The prediction that unemployment will peak at 27.2% also seems optimistic given that there is plenty more austerity and internal devaluation to come while the structural labour market reforms are yet to take effect.

• Oliver Wyman's report strongly assumes that all the previous capital buffers and loan loss provisions have been well implemented with suitable quality of assets. However, this is far from assured;

• The level of non-performing mortgage loans seems incredibly low at 3.3% currently with losses only predicted to rise to 4.1% under the adverse scenario. This number could well be distorted by forbearance (delaying foreclosing on loans likely to default to avoid taking losses) by struggling banks. It will also massively increase if unemployment and economic growth turn out to be worse than predicted;

• The levels of recovery on foreclosed assets seem a bit too positive (admittedly a wide range of between 37% - 79% losses depending on type of asset) given the continuing oversupply in the real estate market in Spain. Until the market has fully adjusted, the huge mismatch between supply and demand is likely to keep resale value on foreclosed assets incredibly low;

• These tests do look to be more intense than the previous ones but ultimately the optimistic assumptions do instantly raise questions over their credibility. The structure of the bailout request is also unlikely to enamour investors, who like to see grand gestures, however, it always positive that taxpayer participation may be limited. 

 

Initial thoughts on Spain's latest austerity budget

We’re still waiting for the full breakdown and figures behind the Spanish budget (which we will analyse and post in due course) but in the meantime here are our initial thoughts:

• The decision to tap the pension/social security reserve fund for €3bn was surprising. Generally this is a fairly last resort approach, but why Spain felt the need to do this to get its hands on only €3bn isn’t clear, especially with short term borrowing costs still low. Could Spain’s liquidity problems be greater than thought?
•  The interest Spain will have to pay on its debt will go up by €9.7bn, compared to a total package of cuts of €40bn (undoing almost a quarter of them). For a country the size of Spain even seemingly substantial cuts can easily be offset by the massive debt burden.
• The majority of the savings (58%) will come from spending cuts rather than tax increases – there is an on-going debate over which is more effective but in the short term spending cuts are likely to harm economic growth (especially given the reliance on the state as an economic driver in Spain).
• Tax revenue is expected to go up by 3.8% - given that growth is likely to falter this seems incredibly optimistic, even with some tax increases.
• The basic macroeconomic forecasts for the budget haven’t changed – this suggests that the overly optimistic growth forecasts are likely still in place, despite most investors and international agencies reducing their forecasts.
• Unemployment is predicted to have topped out this year – again this seems hopelessly optimistic given that structural labour market reforms are yet to take full effect (and there are still more to come) while internal devaluation will need to continue at a rapid pace (see our recent briefing here for more info on this).

So, plenty of issues already, with what seems to be a fairly unconvincing budget given the state of the Spanish economy. 

One final point to note is that Spanish Economy Minister Luis De Guindos kept insisting that the measures were all in line with recommendations from the EU/IMF/ECB troika or in some cases even went further. This looks to be leading into a Spanish reform programme as part of a bailout/bond buying scheme, hinting that Spain may be preparing that request after all.

Creative Bailout Thinking, Spanish Style

One should give some credit to the Spanish government for its determination in trying to make bailouts look like something else. Today's El País reports that Spain is planning to request that the unused money from the €100 billion bank bailout package agreed with the Eurogroup a couple of months ago be used to buy Spanish bonds on the primary market.

This, in turn, should be enough - or at least this is what people in Madrid hope - to convince the ECB to start buying Spanish debt on the secondary market. According to the paper, the results of the independent audit of Spain's banking sector - whose publication has been postponed to 28 September - are expected to confirm that Spanish banks need a total capital injection of no more than €60 billion.

Therefore, the Spanish government is confident that, assuming that banks will be able to raise at least part of the money from alternative sources, it will only have to use less than half of the rescue package for bank recapitalisation - which would leave some €55-60 billion available. In other words, Spain sees the possibility of obtaining ECB support without having to apply for a separate EFSF bond-buying programme - i.e. without having to ask for more money.

Good effort, but too many 'ifs' remain. First of all, the results of the audit should not be taken for granted. As we recently argued, the real capital needs of Spanish banks may turn out to be higher than the €60 billion Mariano Rajoy and his cabinet are currently betting on. Furthermore, even if the €60 billion figure were confirmed, it is fair to assume that Spanish banks may face unreasonable borrowing costs on the markets - compared to what is on offer through the bailout funds. Therefore, they may find it much easier to just ask the government for cash.

Secondly, according to the draft agreement that we published on our blog (see here), Spain does indeed have the right to request that part of the €100 billion be used for purposes other than bank recapitalisation. However, in order for this to happen, the Memorandum of Understanding will have to at least be substantially revised and a whole new one may need to be created. Now, Rajoy is assuming that no new conditions would be imposed if Spain were to apply for a bond-buying programme - and the European Commission appears to share his view. However, it is far from clear whether this will actually be the case (see the recent comments from Eurogroup chairman Jean-Claude Juncker and Dutch Finance Minister Jan Kees de Jager).      

Finally, it remains to be seen whether the ECB or Germany will agree to such a plan, especially since it further muddies the water between bailouts and conditionality - not exactly clear cut as it is under the ECB's bond-buying programme.

Rajoy may have to make a decision fairly soon. The markets do not like prolonged uncertainty, and the first signs of impatience are already visible. Whatever the solution, it will need political approval from all the parties involved, as much as creatively adjusting current plans may seem, there is no circumventing this fact. 

¡Cuidado, Señor Rajoy! The Catalans mean business (and the lesson is for the eurozone)

As we have noted before, whether you sit in Brussels, Berlin or Madrid - and like the idea of more central control - beware regionalism.

The relations between the Spanish central government and Catalonia seem to have reached a new level of tension in the past few days. Somewhat paradoxically, fresh from asking Madrid for a €5 billion bailout, Catalan leaders are starting to talk tough. There have been plenty of hints at independence - although the actual I-word has not been used in public speeches so far.
 
A pro-independence rally also brought Barcelona to a standstill on Tuesday, 11 September - when Catalans celebrate their national day, La Diada. In a perfect illustration of the forces of regionalism, local police said up to 1.5 million attended the rally, while the Guardia Civil (Spain's national police), cited 600,000 as a more realistic number. In any case, there were a lot of Catalans out on the streets.

Fueling the reinvigorated independence mood is Catalan Governor Artur Mas. The "success" of the pro-independence rally, he argued, shows that Catalonia can become "a normal nation in Europe" (during his speech he had only the Catalan and the EU flag behind him, see picture).

Yesterday, the Catalan Governor drew an interesting parallel with the eurozone crisis. He said,

"I think the same is happening between Catalonia and Spain as between northern and southern Europe. Northern Europe has grown tired of southern Europe. And southern Europe has grown tired of northern Europe because of its way of acting. I think that there is mutual fatigue between Catalonia and Spain, too. Catalonia has grown tired of not making progress and Spain [has grown tired] of Catalonia’s way of acting. Catalonia thinks it contributes a lot and is not respected. And Spain thinks Catalonia is always asking and complaining."

He said the time had come for a referendum on Catalonian independence, threatening early elections if Catalonia does not get greater tax collection powers. However, taking his eurozone parallell to its logical end point, he did not say whether the north and south in the eurozone should also opt for a divorce.

Because, as we have argued before (see here and here) and just as the Governor suggests (though, just to be clear, we're not taking any positions in the debate on Catalan independence!), Spain is a microcosm of what may be to come in the eurozone:

• Catalonia wants greater taxation powers since it feels that is losing out under the current system. Only two out of 17 Comunidades Autónomas (the Basque Country and Navarra) are allowed to collect all taxes by themselves, and then send part of the money (the so-called cupo) to the central government. If Catalonia gets the same deal, it says it will save cash. So Catalonia wants to opt out of most of Spain's transfer union. If Spain finds it difficult to hold its together, how much more complicated will it be for the euro to move to a transfer union - and then hold it together?

• And in a perfect illustration of what individual responsibility does: Basque Country and Navarra, the two regions that raise and spend most of their own taxes, are amongst the Spanish regions with the strongest finances (and likely to meet their deficit target at the end of the year). Catalonia is the has the highest debt/GDP ratio of all Spanish regions (see here).

Catalonia is not about to go independent. But this debate is a huge flashing warning sign for the eurozone.         
  

So Bankia is still a viable bank...?

Spain announced its plans for cleaning up its banking sector earlier. With the full legislation only just released, we are still looking through it and will bring you the pertinent points in due course. But there was also another interesting development with regards to the ailing lender BFA-Bankia.

The Spanish government announced this afternoon that BFA-Bankia will receive an "immediate capital injection" from Spain's bank restructuring fund (FROB). Nonetheless, Spain has decided not to request the early disbursement of part of its €100bn bank bailout package. This is despite the fact that €30bn had been set aside for emergencies, as the Eurogroup noted in a statement issued earlier this afternoon. The funds will therefore be paid out in advance by the FROB and will be eventually incorporated into the Spanish bank bailout when it is fully dispersed.

This raises a couple of interesting questions. Firstly, why is Spain so keen to avoid tapping the €30bn kept in reserve? The money is there for just such an occasion, and in fact it was fairly obvious that this exact situation would arise. What's more, the money will be folded into the bailout anyway. Therefore, we can only imagine that the Spanish government is keen to avoid some kind of negative stigma – although this seems slightly strange since the bailout is already confirmed. It is worth keeping in mind the constraints of the EFSF vs. ESM funding (which we covered here), so it is possible that Spain and the eurozone have decided they want to wait until the ESM is fully operational before tapping the funds.

Reading the press release, it is also clear that this is a restructuring of BFA-Bankia, meaning it is still viewed as a viable bank. This seems almost outrageous for a few reasons:

• Bad loans held by Bankia jumped by 44% (to 11%) in the past six months alone
• The group just posted a loss of €4.45bn, compared to a slight profit a year ago
• In the past six months the banking group has lost a staggering €37.6bn in client funds, a massive 28% fall. 

It’s been clear to most for some time that Bankia is no longer viable. The latest government plans for dealing with the banking sector provide for an “orderly resolution” of unviable banks and a template for splitting up its assets and winding down the institution. It is not entirely clear why this is not being applied here, although protecting retail investors could be part of it. In the end, though, investing further public funds into a failing institution will do everyone more harm than good.

Showdowns that will define Europe's future

In today's Telegraph, we argue:

'It will not be the case that the south will get the so-called wealthy states to pay. Because then Europe would fall apart.” Thus spoke Horst Köhler, former German president, finance secretary and IMF head, almost two decades ago. 

Köhler’s remarks are worth pondering. A series of multi-billion-euro bail-outs – and more to come – have now planted a north-south political divide at the heart of the European project. Taxpayers in Europe’s north resent underwriting their southern neighbours, while voters in the south are equally frustrated at having austerity imposed upon them from abroad. As has been noted repeatedly, this is the greatest tragedy of this crisis: a project that was meant to bring people together, now risks driving them further apart. Alas, events in the eurozone this autumn could further exacerbate this tension. There are at least five key stand-offs to watch over the next few months:

Greece v Germany: Greece managed narrowly to escape running out of money today by raising almost 4 billion euros in short-term debt. But Athens will face an excruciating autumn. On almost every count, Greece is miles away from meeting its EU-mandated austerity targets, which raises the questionof whether Germany – or the IMF – will pull the plug on the country in October when its next progress report is due.

Though there is still scope for muddling through, almost any outcome will lead to rising political tensions. If Germany sticks to its guns, the popular disillusion in Greece will grow massively. If Berlin gives in, it faces a serious backlash from the country’s public – a majority of which wants to kick Greece out.

Spain v the North: Amid continued problems, Spain could possibly request EU cash as early as September. But the country is simply too big for a Greece-style bail-out, while Madrid would not accept having its economic policies fully decided in Brussels and Berlin. Instead a third way must be found involving less money and softer conditions, probably with heavy and controversial ECB involvement. The North will dislike such an arrangement – particularly cheap ECB money going to Spain – but may give in for fear of worse.

The bail-out funds v national democracy: On September 12, Germany’s constitutional court will rule on whether the eurozone’s permanent bail-out fund – the European Stability Mechanism (ESM) – is compatible with the country’s “basic law’, following a host of complaints. Though unlikely, should it strike it down, the markets will go absolutely crazy. Regardless, the ruling will leave a bad taste in Germany and shows how the ESM is becoming an increasingly toxic issue, with southern and northern politicians disagreeing fundamentally on its size and whether it should be given a direct credit line to the ECB.

The Dutch v Europe: September 12 will also see another example of national democracy reasserting itself: the Dutch elections. Geert Wilders, leader of the super-populist PVV, is seeking to turn the campaign into a referendum on Europe, hoping to tap into the Dutch anti-bail-out mood. At the same time, the Dutch socialists – currently leading in the polls – have vowed to resist both the EU fiscal treaty and further transfers of power to the EU without approval in referendums. A divided Dutch parliament and more assertive government will almost certainly make eurozone politics even more complicated.

Germany v France: This autumn will also see negotiations over whether the eurozone will take the next big leap towards an economic union, with an October EU summit tasked with providing a “road map” for more integration. Ideas include a banking union (with a single supervisor and joint backstop) and collective government borrowing in the form of eurobonds. The issues are tremendously complicated, subject to a cobweb of disagreements and will take years to clear away. But importantly, this could widen the gap between Germany and France, with the two disagreeing fundamentally on the order of events. Berlin wants a political union first, meaning greater German control over others’ finances in return for underwriting them – while Paris wants to press ahead with stronger bail-out mechanisms, via the ECB and others, leaving the oversight for later. The Franco-German axis is not about to break, but maintaining it will become increasingly difficult.

So how should Britain respond to all of this? Simple: try to control what it can control and leave the rest behind. The UK is right to seek to buffer up against a potential euro meltdown. It is also right to look for ways to ensure that further eurozone integration – such as a banking union – is not detrimental to Britain or the single market. But the UK government needs to stop giving unwelcome advice on the need to turn the eurozone into a “debt union” or for the ECB to start spraying the Continent with cheap money – both options effectively involving Angela Merkel completely running over her own voters.

The eurozone crisis has unleashed some seriously unpredictable political forces. EU leaders may have to choose between maintaining the euro and maintaining national democracy as we know it. In either case, we have no idea how voters – in the North and South alike – will respond.

 

The day after Draghi: Contrasting views from Spain and Germany

The day after the monthly meeting of the ECB's Governing Council and Mario Draghi's subsequent press conference - during which he said that the ECB is willing to intervene on the debt markets again but will hold fire for the moment - we've summed up a few media reactions from Spain and Geremany, opposite sides of the debate on what the ECB's role in the crisis should be. The discrepancy between what the Spanish and German press have made of Draghi's words is fascinating.

An article in El País with the headline, “Draghi pushes Spain towards another bailout” argues that:

"With a single shot, Draghi has shifted all the pressure onto [eurozone] countries verging on intervention. That is, onto Spain. Therefore, Mariano Rajoy’s government finds itself in the thorny condition of someone who has to choose between requesting a bailout – the second, after the one for [Spanish] banks less than two months ago – or burn in the markets."

A similar headline in Spain’s main business daily Expansión reads, "Europe pushes Spain towards a soft bailout”. Interestingly, the paper notes,

"Make no mistake. Neither is Draghi the first high-ranking European official to show Spain the way to the [eurozone] bailout funds, nor did the [Spanish] government realise yesterday that this is what it is being asked to do."

In fact, the article goes on, other top European politicians, from EU Competition Commissioner Joaquín Almunia and Eurogroup Chairman Jean-Claude Juncker, made similar remarks over the past few weeks.

An opinion piece in another Spanish business daily, El Economista, carries the headline, “ECB to Spain: Seek a bailout”. The article says,

“The ECB is now an inoperative institution, the guardian of an ancient orthodoxy. At the moment, the ECB doesn’t want to be the solution…but is part of the problem…Spain will predictably see itself obliged to ask for a bailout. Sooner or later, the fearsome Troika (ECB, IMF and European Commission) will take the helm of our economy and our [public] accounts.”

Bernardo de Miguel, Brussels correspondent for Spanish business daily Cinco Días, writes on his blog that Draghi has made Italy and Spain a Godfather-style “offer they can’t refuse”, adding,

"Madrid and Rome have few options at their disposal, apart from Draghi’s offer, if they want to avoid a full bailout."

Meanwhile, over in Germany, the media have focused more heavily on the implications for German taxpayers and the fraught relations between Draghi and Bundesbank President Jens Weidmann.

Mass circulation Bild, referring to the lack of concrete details announced yesterday, carries the headline, “Could…Would…Should…What does Draghi’s euro wishy-washy mean for our money?” Still, the good news for Draghi is that as long as the ECB’s ‘monetary floodgates’ remain closed, Bild have said he can keep his Pickelhaube.

Writing in Die Welt, Sebastian Jost is less complimentary towards Draghi, accusing him of “taunting” the Bundesbank. Jost argues that:

"ECB Chief Mario Draghi obviously feels comfortable in his role of the euro-saviour. However, not yet able to offer money, he had to make do with strong words and hidden side-swipes."

An article on Handelsblatt’s frontpage asks, “How long can [Bundesbank President Jens] Weidmann hold out in isolation?”, arguing that:

“At the ECB headquarters in Frankfurt, the warnings from Germany are hardly being heard, and they clearly have no influence on decision-making.”

However, Draghi could console himself by reading FT Deutschland’s leader, entitled “Draghi’s wise plan”, which interestingly argues that:

"It would have been good not to interfere with the psychological impact of Draghi's announcement. But once again opposition came from Germany, from the head of the Bundesbank, Jens Weidmann, apparently the only one who voted against Draghi's plan in the Governing Council… It is indeed unwise to break the ranks of the Governing Council in this situation. Weidmann is fanning mistrust where he should be fostering confidence."

Two countries, two completely different roles in the eurozone crisis, two completely different interpretations of the same words. Meanwhile, European stock markets seem to have recovered from yesterday's losses. The interest rate on Spain's ten-year bonds has also decreased, after peaking at over 7.4% this morning.

The situation looks increasingly like another eurozone 'game of chicken'. On the one hand, Draghi yesterday effectively urged eurozone governments (primarily Spain, but also Italy) to show their hands first -  that is, if they think they need help to bring their borrowing costs down they should request EFSF assistance. But at his press conference less than two hours ago, Spanish Prime Minister Mariano Rajoy insisted that he first wants to see what the ECB's announced "non-standard monetary policy measures" actually involve, adding that, as regards the possibility of Madrid asking the eurozone bailout funds to buy Spanish bonds,

"I haven't made any decision. I will do what suits the general interest of Spaniards."

Who will blink first?

Spanish government vs Spanish regions: Episode 98,640 (and counting)

Fresh skirmishes between the Spanish government and some Spanish regions have taken place this afternoon, both ahead and during the meeting of the so-called Fiscal and Financial Policy Council - a forum for the Spanish Treasury Minister Cristóbal Montoro (pictured) to meet his regional counterparts.

The meeting is currently still under way, and the main item on the agenda is the 1.5% of GDP deficit target that Spanish regions will have to meet by the end of the year. As we argued in our recent briefing, the target seems unattainable for at least seven of Spain's 17 Comunidades Autónomas - which are expected to make cuts worth over 2.5% of their GDP.

Despite recently having its deficit targets relaxed by the European Commission, the Spanish government has refused to do the same for its regions. Reports in the Spanish press widely suggested that today's meeting was simply going to confirm that all regions will have to cut their deficits to 1.5% of GDP by the end of the year - even if this involves making additional budget cuts.

The government's decision has not gone down well with certain regions - to put it mildly. Thus, Catalonia this morning decided that it would boycott the meeting altogether. In the words of the Catalan government spokesman, Francesc Homs,

There's no point attending a meeting when everything has already been decided before.

Fair enough. But quite controversial, given that Catalonia is one of the three Spanish regions which have already declared that they will ask the central government for a bailout. Furthermore, Catalonia's minority government, led by nationalist Convergència i Unió party, is only able to govern with external support from Spanish Prime Minister Mariano Rajoy's Partido Popular.

And there is more. Andalusia - Spain's most populous region along with Catalonia - did go to the meeting with Mr Montoro, but abandoned the 'negotiating' table in protest against the government's decision to leave the 2012 deficit target for regions unchanged.

As we have argued here, regions will not make or break Spain financially. However, the latest events are yet another indication of how the clear difficulties in reining in spending at the regional level can undermine the Spanish government's credibility vis-à-vis its eurozone partners and the European Commission.

P.S.: Not really a regional issue, but still related to Madrid's credibility. The Spanish government was due to send its budgetary plans for 2013-14 to Brussels by the end of today, but has failed to do so. Perhaps not the biggest of deals, but the deadline was part of the agreement under which Spain was given an extra year to bring its deficit below 3% of GDP.  

Who said it?

A quick-fire Friday afternoon quiz for our readers. Who said the following in February 2011?

"As a Spaniard, I don't like being told what I have to do from outside."

Well, it was Spain's then opposition leader Mariano Rajoy, who was elected as Spanish Prime Minister a few months later.

Will Rajoy have to eat his words...?

Could this 'concerted action' fly?

Today's edition of French daily Le Monde - which, unlike a large majority of newspapers, is delivered to newsagents at noon - features an interesting story.

According to the paper, the ECB and eurozone governments have intensified talks about the possibility of launching a 'concerted action' to keep Spain's (but also Italy's) borrowing costs at reasonable levels. The recipe is quite simple. The first step would be the eurozone's bailout funds - the temporary EFSF and, as soon as it is up and running, the permanent ESM - buying Spanish/Italian bonds on the so-called primary markets, where national treasuries try to sell newly-issued public debt.

The ECB would follow suit, and would resume its bond purchases on the secondary market - after keeping quiet for almost five months. This would tackle the short-term emergency. The second step, according to Le Monde, could be giving the ESM a banking licence, so that it can have unlimited access to ECB liquidity.

In order for this 'concerted action' to kick off, though, Spain has to make a formal request for an EFSF bond-buying programme. According to the paper, this could be overcome by offering Mariano Rajoy's government 'softer' conditions.

Sorry for once again being the bearers of bad news, but this is not as easy as it sounds. First of all, the Spanish government remains very reluctant to request anything the markets may see as a fully-fledged bailout. Just think of how consistently Rajoy and his ministers have avoided using the word rescate (bailout in Spanish) when referring to the €100bn rescue package for the Spanish banking sector. Secondly, giving Spain 'softer' conditions could potentially open Pandora's box and prompt Greece, Ireland and Portugal to ask for the same treatment.

On top of this, there are also other problems with this 'concerted action', which Le Monde seems to overlook. Should the EFSF start buying bonds, this would not necessarily mean that the German Bundesbank would suddenly change its mind and support massive bond market interventions by the ECB. See, for example, the Bundesbank's reply to Mario Draghi's latest remarks. Unusually late by German standards, but no less categorical in making clear that the bank "hasn't changed its opinion" (i.e. its opposition) to such interventions.

Now, unanimity in the ECB's Governing Council is not needed with regard to bond purchases. But it would be politically very difficult to outvote the Bundesbank over and over again - not to mention that the Dutch and the Finns are likely to be sympathetic to the German concerns. On a more technical note, bond purchases on the primary markets can be addictive, similar to what has happened with ECB liquidity to eurozone banks. In other words, it could be quite difficult for, say, Spain to finance itself in a normal fashion after EFSF/ESM purchases are phased out. As we have stressed before, no-one wants to see a situation where the eurozone faces zombie states similar to the peripheral zombie banks now reliant on ECB liquidity.

All very speculative at the moment (Le Monde does not actually mention any specific sources), but it's clear that things are moving quickly. Keep following us on Twitter @OpenEurope if you want to keep up to speed!