Spain faces crunch today on austerity budget

Government move seen as the precursor to a full-blown rescue package for struggling banks

PUBLISHED : Thursday, 27 September, 2012, 12:00am
UPDATED : Thursday, 27 September, 2012, 3:07am


Squeezed by financial markets and denounced in the streets, Spain's government is due today to adopt an austerity budget which could be a precursor to a full bailout.

The final step before a rescue is likely to come tomorrow, analysts say, when Madrid unveils an independent audit of its limping banks to determine how much capital they need.

Spain's euro-zone partners have agreed to provide a rescue loan of up to €100 billion (HK$1 trillion) to help the banks recover from bad loans built up after a 2008 property crash, but Madrid insists €60 billion will be enough.

Once that matter is dealt with, the euro zone's fourth-largest economy will have all the data it requires to seek a broader, sovereign rescue from bailout funds.

If Spain bends to the will of the markets and some of its euro-zone partners by formally requesting the bailout, it will trigger a bond-buying programme for troubled states outlined by the European Central Bank on September 6.

That would curb Spain's borrowing costs, but before making the leap, Prime Minister Mariano Rajoy wants to know what the conditions will be.

The conservative leader also is likely to have wanted to make progress on the budget for next year before making the request.

The basic outline for the budget has been known since July. The plan to be adopted by the cabinet today is expected to enact spending cuts and tax increases worth a combined €39 billion.

The government aims to claw back more than €150 billion before 2014, saving €62 billion this year, €39 billion next year and €50 billion in 2014.

On the austerity menu for next year are an increase in sales tax and other taxes which are expected to rake in €15 billion and almost €7 billion will be found from cuts in the regions, which manage health and education.

Other savings come from lowering unemployment benefits and social assistance, as well as a freeze in public sector hiring.

But Spain probably would have to go further, said Juan Ignacio Conde Ruiz, a deputy director of the Foundation of Applied Economic Studies.

"To be credible with the markets, which is the government's ultimate goal, it would seem hard to avoid touching retirement pensions, which account for 25 per cent of total spending," Conde Ruiz said.

Rajoy's election campaign promise to maintain pensions indexed by inflation would cost up to €3.5 billion, he said.

That, he said, would make it impossible for Spain to meet its commitment to slash the public deficit to 6.3 per cent of gross domestic product this year from a runaway 8.9 per cent last year.

"There won't be the means to do it," said Jesus Castillo, a European specialist at French bank Natixis. "So we should not be surprised by a freeze in pensions."

He said there also was the possibility of a cut so as to stay on track with the target for next year of a deficit equal to 4.5 per cent of GDP.

Despite the analysts' doubts, the government insists pensions are going up, not down, as it faces growing protests to the austerity measures including hundreds taking to Madrid's streets on Tuesday.

Deputy Prime Minister Soraya Saenz de Santamaria said the new level for pensions would be decided in November. "Will pensions go up? Yes, pensions are going to go up. Pensions will obviously be adjusted for the cost of living," she said.

At the Spanish investment bank Inversis, analysts predict the public deficit forecasts will be revised higher for this year and next year in line with a deeper-than-expected recession.

Today, a new package of reforms negotiated with Brussels to stimulate business activity and exports also will be announced, "which could be the stage prior to a bailout request", according to a report by Spanish brokerage Renta4.

If Spain fails to take convincing action, the verdict could come quickly.

Moody's Investors Service has until Sunday to decide whether to downgrade Spain's debt. If it does so, it could be the first agency to rate the nation's debt at the equivalent of a junk bond.

The country's budget and economic reform announcements were aimed at addressing just those concerns, Conde Ruiz said.