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.

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.  

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.