No exit in sight to Spanish crisis

Spain is in crisis management mode. A perfect storm of budget cuts, tax increases and regional bank insolvency barrage the eurozone’s fourth largest economy without relent. Markets clamour for a second bailout, troubled regions go cap-in-hand to Madrid and civil unrest is on the up. The capital saw violent clashes between protestors and police outside its _cortes_ (parliament) last week.

Its ruling conservative Popular Party (PP), elected on a mandate for economic literacy, receives widespread criticism and if its fudging prime minister, Mariano Rajoy hadn’t enough headaches, upcoming regional elections loom. What began as an economic crisis has now become a veritable political one. Should the government collapse, Spain has no strongman, nor unruffled technocrat like Italy’s Mario Monti to fill the void. The situation is grave.

Under revised austerity measures announced last Thursday, government spending will be slashed by 9 per cent next year. This means freezing public sector worker pay, reducing pensions and scaling back unemployment benefit to make up the €39bn of cuts needed for Spain to reach its fiscal target. This constitutes in turn 4.5 per cent of economic output, in a country mired in recession and due to contract 1.8 per cent this year and next. With unemployment soaring at one in four, only a shrinking number can haul Spain out of deepening crisis. The country now has two workers to every pensioner.

To add to the pain in Spain, an independent audit of the stricken banking system has identified seven out of 14 banks to be at risk. Stress tests by Oliver Wyman, a consultancy believe €60bn is required to stop the rot. The lion’s share will come from public funding, though doubts persist over its ability to raise crucial capital, even further to June’s €100bn EU bailout. Mr Rajoy’s labelling it the ‘largest transparency exercise ever done’ demonstrate nonetheless his compliance with EU officials and doggedness to take decisive steps to calm investors, whatever the popular uproar.

One of these is the establishment of an €18bn war chest fund to provide liquidity to profligate regions. Catalonia, Andalusia and Valencia have been quick to appeal for €5bn, €4.9bn and €4.5bn respectively. A mere €2bn remains however, should it come to fruition. Borrowing costs have abated thankfully following such action below the seven per cent threshold deemed unsustainable for governments to borrow. However total regional debt stands at €180bn with public debt heftier still, at €800bn.

Markets stay hawkish. Will the Spanish people continue to tolerate austerity indefinitely? Bertold Brecht’s witticism ‘[w]ould it not be easier,/ for the government to dissolve the people/ and elect another?’ captures aptly the government’s mood. And now repeated overtures to separatism unsteady its footing further. While the Basque Country and Catalonia – the country’s most prosperous regions – enjoy varying levels of independence, they resent paying a disproportionate contribution to poorer regions with which they feel little affinity.

All the more pertinent then that regional elections in Galicia and the Basque Country have been brought forward to 27 October. Aitor Hernandez-Morales, a Madrid-based director of communications views the elections as decisive. Opposition parties will use the PP’s standing as a ‘source of fervent hate’ to spur on minority parties to be ‘more combative to provoke the administration’s collapse’, he believes.

While Spain continues to witness capital flight and the drain of skilled workers, the coming months will test the government’s mettle. A return to the peseta is still not entertained seriously: Spain is committed to the Euro. Although centrifugal forces for independence can for the moment be held off, and new laws pushed through by the PP’s sizeable majority, people power cannot be suppressed forever. No matter how intractable the situation, this will chart the ultimate direction of Spain.