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.

Heading Towards A Bitter 'Finale'?

We've been here several times before, and we know that big surprises are always around the corner with Italian Prime Minister Silvio Berlusconi. However, this time Il Cavaliere's exhausting political twilight might really come to an end. In fact, Berlusconi is due to deliver a keynote speech in the lower house of the Italian parliament tomorrow morning (it was initially expected for this afternoon), outlining his government's priorities for the following months. The programme will then be put to a vote of confidence on Friday. If Berlusconi fails to secure a majority, he will almost certainly have no choice but to step down.

The decision to require a confidence vote is clearly not a bolt out of the blue. Yesterday was a bad day for Berlusconi and his government, which was dealt at least three hard blows. First off, the lower house of the Italian parliament failed to approve the first article of the 2010 budget review - a bureaucratic document whose adoption is usually a mere formality.

Details of the outcome of the vote are key. The government needed a majority of 291, but stopped at 290 votes. Quite significantly, both Italian Economy Minister Giulio Tremonti and the leader of junior coalition partner Lega Nord Umberto Bossi were in the parliament building, but did not take part in the voting, with Tremonti (provocatively?) entering the room a few moments after the verdict. Following the vote, prominent members of Berlusconi's party - including Defence Minister Ignazio La Russa - urged the Prime Minister to verify whether the government is still supported by a majority in parliament.

In the second place, the Italian Court of Auditors slammed the Italian government's draft reform of the tax system, due to uncertainties over its financial coverage. The proposed reform is a centrepiece of the set of austerity measures aimed at achieving a balanced budget by 2013, as it is expected to recover around €20 billion over the next three years (mainly through the abolition of hundreds of tax breaks currently into force).

Finally, the European Commission criticised the Italian government's plans for a tax amnesty, warning that the resort to “non-permanent measures such as a tax amnesty in order to achieve a balanced budget by 2013 harms the credibility of Italy’s deficit and debt reduction strategy.”

In other words, the Italian government is under fire on all fronts. Indeed, Berlusconi was in a similar situation last December, but he managed to win the confidence vote thanks to a bunch of opposition MPs - later remunerated with a few government assignments - defecting to his ruling coalition. However, the situation now looks quite different. Over the past few weeks, Lega Nord leader Umberto Bossi has repeatedly hinted to the possibility of early elections, saying that he thought it "objectively complicated" for the ruling coalition to remain in office until 2013, when the next general elections are scheduled. Therefore, Lega Nord MPs' favourable vote is not a done deal, at least for the moment.

But the worst news for Berlusconi may come from inside his own party, as a group of 'rebel' MPs and Senators led by former ministers Giuseppe Pisanu and Claudio Scajola has been calling for the formation of a "transitional government", possibly open to centre parties. The votes of this group of MPs could be decisive.

The situation looks extremely fluid at the moment, with some media reports suggesting that, due to growing pressure from Lega Nord, Berlusconi might call early elections next year even if he wins Friday's vote. This is not necessarily bad news, despite Italy's precarious economic situation. What Italy badly needs now is a stable and credible government to implement, among other things, the reforms demanded by the ECB (see here and here). After all, the markets are not hanging Spain out to dry, even after Prime Minister José Luis Rodríguez Zapatero announced early elections...

And they're off! What will the Spanish elections mean for the eurozone and the UK?

News in earlier today, Spanish Prime Minister José Luis Rodríguez Zapatero has finally set a date for national elections - 20 November. Parliament will be dissolved on 26 September. As expected, Zapatero will step down and make way for a new socialist party leader, Alfredo Perez Rubalcaba (pictured on the right), who was selected by his party earlier this year.

Elections were originally planned for early 2012, with an ultimate deadline of March 2012, but in view of the economic crisis and increasing pressure from the public, the press, the opposition, and some members of his own party, Zapatero finally caved in today. Spain’s main opposition party, the Partido Popular (PP) are now tipped for a big win, according to opinion polls and the PP’s recent successes in regional elections. However, Spain’s economic problems indicate that stormy times are ahead.

“I have chosen the date to project economic and political certainty”, Zapatero said. Conveniently for Zapatero, October’s budget will now be delayed until next year, after the elections. The election campaign will now certainly be dominated by the impending budget, and the need for deeper austerity cuts. This debate could be tricky for the PP, who will have to strike a balance in the election campaign between identifying in detail the cuts it envisions, and not scaring the electorates back into the arms of the Socialists. And with an eye on the Conservatives' record in last year's election campaign in the UK, the PP will want to avoid leaving any sort of impression that it's flip-flopping over cuts. What's clear is that whichever party ends up at the helm will have to make tough decisions to navigate Spain through the eurozone crisis’ Bermuda triangle.

El Pais also notes cynically that the date of the election happens to fall on the anniversary of the death of Spain’s notorious right-wing dictator Franco. The left-wing government was quick to dismiss the ‘coincidence’ saying it’s a date “like any other”.

A few questions:

What will this mean for the eurozone crisis? Well, the timing of the elections may not buy Spain any favours with financial markets. The uncertainty that comes with any election is far from ideal given the already rising borrowing costs. In addition, the election will put a complete pause on the economic reform and austerity programmes. It's also unclear whether the expanded EFSF will get ratified by the Spanish Parliament before the election - something which the French and German governments, not to mention investors, are keen to see done asap. If Spain misses any important targets over the next few months due to the elections, be sure that the markets will push borrowing costs even higher.

How will a PP-led government differ from a Socialist one? At a recent event of ours, the PP's Secretary of Economy and Employment Álvaro Nadal set out his priorities for the coming years noting that the PP will go much further on labour market reforms than its predecessor, particularly with changes to the collective bargaining system, in addition to more privatisations and stricter budget conditions for regions. In terms of restructuring the Cajas (the regional saving banks), it looks as if PP will continue where Zapatero left off, since the reforms were very much based on a cross-party deal in the first place. Nadal suggested that the mandate given to the PP in the recent regional elections and polls shows that the people are ready and willing to accept these reforms. Once past the uncertainty of the elections, a Spanish reform-minded government, with a strong mandate from the electorate, can only be good news for the eurozone.

Interestingly, Nadal said that a PP run government would probably not support Eurobonds - which is becoming increasingly fashionable as a "solution" to the eurozone crisis. Nadal said,"For [Spain] it would be suicidal. The current eurobonds are very ill-designed. We need a method to encourage fiscal discipline but they are not it". Nadal concluded by reiterating a stance taken by Mervyn King, Governor of the Bank of England, saying, “We have been treating this as a liquidity problem when actually it is a solvency one”.

How will social discontent in Spain impact on the elections? Intertwined with its economic problems, Spain is also suffering from serious social discontent at the moment. The so-called ‘indignados’ (indignant protesters) will pose a serious challenge to both parties during the election campaign, but probably hurt the incumbent government the most. Support for the indignados is high and growing, not really a surprise in a country with unemployment rates of 21% (climbing to 45% youth unemployment). Last weekend saw crowds of 35,000 march through Madrid, more are on the way.

What will this mean for the UK? In fact, a PP victory is Spain could provide the Coalition with a potential centre-right ally in Europe at a time when both Germany and France could see centre-left governments take over within the next two years. And there's scope for deals to be struck between the Coalition and a PP-led Spanish government, including on some crucial economic issues such as services liberalisation, the EU better regulation agenda, bank recapitalisation, and potentially also on external trade. (However, other areas will be trickier, including the EU budget where any Spanish government and any UK government are poles apart).

What's clear is that a successful Spanish economy is absolutely vital for the health of the eurzone and the European economy. A vibrant Spain would do a lot to get the eurozone back on track.

The week when EU politics was turned on its head

It has been an absolutely extraordinary week in European politics. A Con-Lib coalition government has been formed in the UK; the eurozone has been shaken to its very core amid the ongoing sovereign debt crisis; European leaders have agreed on a mind-boggling rescue package worth some €500 billion (and killed the no bail-out principle in the process); the European Central Bank has done what previously was unthinkable and intervened directly in bond markets; the Commission has tabled proposals to give the EU the mandate to sign off national budgets; Angela Merkel has called for a Treaty change to toughen up the Stability and Growth Pact (also calling for a European Army while she was at it); and the UK has become isolated on the very symbolically and economically important AIFM Directive (although the FT was unnecessarily hysterical today).



Phew!!

And today we learn from Spanish El Pais that according to Spanish PM José Luis Rodríguez Zapatero, Nicolas Sarkozy threatened to leave the euro over the weekend unless Germany coughed up money to help Greece and other struggling euro-states. The revelation – which is being denied ferociously by everyone involved – sent the euro tumbling today.

This is what El Pais writes:

“It happened this Wednesday in a meeting with regional and provincial party members in Ferraz. [Zapatero ] gave a speech for over two hours” recapping part of “the eurogroup meeting in Brussels last week. He underlined that Sarkozy had threatened to remove France from the euro.”

It goes on,

“[Zapatero] had a bad weekend in both Brussels and Madrid. But he wasn’t the only one. The tensions experienced by the Eurogroup leaders were such that a moment arrived when they split into two fronts. On one side France, Spain and Italy. On the other side, Germany. [Zapatero] outlined to the members of the [Spanish party] PSOE [Spanish Socialist Workers' Party] ‘the unusual financial turbulences’ that Europe has seen in the last ten days. And he illustrated the complicated tension of the Eurogroup with some internal comments made by Sarkozy, which those who heard them interpretated as threats. Zapatero said that Sarkozy came to demand a ‘commitment from all to help Greece’ or France will reconsider its position on the euro.’”

One of the people in the audience apparently drew the conclusion from Zapatero’s speech that “Sarkozy had hit his fist on the table and threatened to break away from the euro, which forced Angela Merkel to change her mind and reach an agreement."

Another person in the audience concluded from Zapatero’s speech that “France, Italy and Spain formed a common front against Germany, and Sarkozy came to threaten Merkel with a break in the traditional Franco-German axis."

According to the reports, Sarkozy had also said “"if at time like this, with all that is happening, Europe is not capable of a united response, then the euro makes no sense".

The expression "a week is a long time in politics" feels like an understatement all of a sudden.