The Potential Consequences of Rescuing Spain
First, it was Greece. Then, it was Ireland’s turn. And later, Portugal became the third country in the eurozone to need a rescue. Today, all eyes are on Spain, which could become the next country on that list. Analysts and other observers assume that the Spanish government will ask the European Union (EU) for help in dealing with its debts. The only question is: When will that happen?
On September 26, Spanish Prime Minister Mariano Rajoy told The Wall Street Journal that if interest rates continue to be “too high for too long,” he will ask for “a rescue of one-hundred percent.” A partial rescue had already taken place already in June, with the concession of a credit line of as much as 100 billion euros to restructure the Spanish banking sector. Nevertheless, the latest statements from European institutions have cooled off expectations that a rescue request is imminent. “Spain does not need any assistance program. Spain is doing everything it needs to do with respect to fiscal policy and structural reforms,” declared Wolfgang Schäuble, Germany’s finance minister, during the October 8 summit meeting of Eurogroup, an organization that coordinates the economic and political strategies of the EU.
“Obviously, a rescue is not something that you undertake unless there is no other alternative. But the available options are ... only feasible with the participation of the eurozone,” says Santiago Carbó Valverde, professor of economics and finance at the Bangor Business School in the U.K. According to Carbó, “there are multiple consequences for Spain if it requests a rescue, and they depend to a large extent on how this aid request is orchestrated.”
Carbó notes that the conditions under which aid is being negotiated in Spain and Europe are different from those that existed when previous requests in other countries were initiated. “The context itself is a unique one because this possible rescue is being arranged in a more general framework of the establishment of mechanisms of financial solidarity and banking union, on the one hand, and of fiscal control, on the other.” He points out that the case of Spain may be significantly differentiated from the cases of Greece, Ireland and Portugal “to the extent that, in this case, it has been born in an environment in which people are seeking to settle the foundations of the European banking union. In September, the European Central Bank announced its new program of buying the sovereign debt of countries that have financing problems. This involves simultaneously reducing country-risk at the same time as achieving a program of credible financing and consolidation of public accounts, thus restoring confidence in Spain,” he says.
The EU has already begun to set up its European Stability Mechanism (ESM), which is the permanent rescue fund of the eurozone. The ESM will contribute money to Spain whenever it requests aid under a formal process. This mechanism has an initial loan capacity of 200 billion euros, but it will increase to 500 billion euros over the next 18 months.
What remains to be seen is how exactly the aid from the ESM will be assembled. On October 4, Reuters reported that one of the options under discussion calls for the new fund to guarantee between 20% and 30% of each new Spanish bond issue, which would reduce the cost of the rescue for European contributors. The plan would only cost some 50 billion euros a year, and it would permit Spain to totally cover its financing needs. It would also enable the European Central Bank to undertake the purchase of Spanish bonds on the secondary market.
Spainhas covered practically 90% of its financing needs for 2012, according to its Treasury. For 2013, the country’s gross needs call for issuing 207 billion euros in debt, so the option to insure losses of 50 billion euros should easily allow it to capture that amount from private investors.
Another rescue option involves having the ESM purchase Spanish debt directly through bond auctions. The regulations of the ESM fund permit it to acquire up to half of each bond issue within the assistance program. In addition, the regulations establish that a preventive line of credit should amount to between 2% and 10% of the GDP of the country, which means between 20 billion and 100 billion euros in the case of Spain. The program would last one year, and would be renewable twice -- each time for a period of six months.
Javier Andrés, professor of economic analysis at the University of Valencia, argues that for Spain, the largest result of a rescue plan would be to reduce the country’s financing costs. “Financially, this would be very appealing for the government and for companies as well,” he asserts. At the same time, Andrés believes that if the ECB buys debt in the secondary market, “it would send a very strong signal to investors that the euro is not going to collapse; that it is irreversible, and that there is a commitment for things to be that way. This would limit the significant capital flight that Spain and the European Union are suffering at this time.”
Rafael Pampillón, professor of economic analysis at the IE Business School, does not expect the petition for assistance to stigmatize the Spanish economy, although he believes that this would depend on how this process is carried out and how it is explained to the public. It might stigmatize the country only “to the degree that people identify this request for assistance with [other] measures that were carried out by Greece and Portugal.”
Pampillón believes that the best option for helping Spain would be if “the ECB bought sovereign debt in the secondary market, which would lower interest rates on bonds, and reduce the risk premium -- and that would enable the country to finance itself much more cheaply.” Certainly, he says, that “would be enough.” Pampillón does not believe that the ESM needs to acquire bonds directly via Treasury auctions, and he says that Spain’s getting out of the international debt market is not a possibility. In that case, Spain would have to stop issuing debt for years, the way Argentina stopped doing so after its famous “corralito.” “Europe does not want this to happen, among other things, because we don’t know what the consequences might be.”
If Spain opted to request assistance, the country would have to sign a memorandum of understanding with its European partners, committing itself to implement austerity measures and economic reforms that guarantee that it restructures its finances and guarantees its future economic growth. At the same time, Spain would have to accept international monitoring of its compliance under such a commitment.
On numerous occasions, the government of Mariano Rajoy has insisted that any request for assistance would not mean adopting new economic adjustments because the country is also complying with requirements that have been previously outlined by the EU in Brussels. If the European Union does impel Spain to adopt new measures, Spain’s executive branch would face an even more difficult situation from a political and social point of view. In recent weeks, public protests against austerity measures have been carried out. The most serious incident, with the greatest repercussions, occurred on September 25 in Madrid, when a demonstration near the Congress of Deputies led to a confrontation between police and the public. Sixty people were wounded as a result, including 27 policemen, and 26 were arrested.
The Pension System and Health Care Cuts
Andrés believes that Spain’s economic future will hinge on the conditions that are negotiated for the rescue package. “From a fiscal point of view, there is very little room for maneuvering,” he notes. “In addition, new short-term tax increases would be very negative, given the recessionary conditions that the country is experiencing today.” On the other hand, Andrés believes that it would be “very helpful” if the EU demanded structural reforms, because such measures would help establish the foundations for future economic growth.
Andrés adds that the EU could ask Spain to deepen its latest labor reform initiative, since it “clearly could be improved.” He suggests that it is important, once and for all, to break the dichotomy that exists between part-time workers and those who have full-time work contracts. The latter group enjoys advantages when it comes to levels of protection.
He also points out that the EU could demand that Spain move ahead with applying the changes that it had previously approved for Spain’s pension system, which involve increasing the age of retirement as well as the number of years used when retirement compensation is calculated. “They would have to make progress with a great deal of these reforms. They need to reduce spending on pensions, relative to Spain’s GDP, by a couple of percentage points in order to achieve any significant savings in this game in coming years.” Andrés says that he also hopes that the rescue plan compels Spain to reduce its health care expenditures, lower its overall public-sector spending, and reorganize its tax system.
Pampillón predicts that the requirements of the rescue plan will have to be negotiated. But he doesn’t believe that the plan will go beyond the measures that the government has already taken or that it will mean any important change from the current situation. “It’s been quite a while since the country said goodbye to economic sovereignty. The recently announced General Budgets of 2013 have been worked out in agreement with the so-called Troika (ECB, EU and IMF). [The Spanish government doesn’t] make any economic decisions without consulting with [all three of] them.”
According to Pampillón, Spain now benefits from an advantage: Following the rescues undertaken by Greece and Portugal, “any policies that impose strong economic adjustments [on a country] are denigrated as the wrong road to take, now that it has been shown that this sort of approach brings on a strong recession. The best thing for the Spanish economy would be to grow to some extent before [the rescue plan begins] -- for things to go well [for Spain] so that the rest of the European Union also expands.”
After any rescue takes place, if “Spain winds up getting into a new recession -- such as the one in Greece -- which demonstrates that it has not solved its economic problems, then doubts about the euro would erupt in the market, which would focus its attention on the next country on the list -- Italy,” Andrés notes.
Along the same lines, Carbó believes that the success or failure of the Spanish rescue plan will have very important consequences for Europe. “When all is said and done, beyond Spain and Italy and other economies on their periphery, what is at stake now is the future of the [entire] Eurozone. The means of assistance established in the case of Spain can serve, as well, to support such economies as Italy, and as general firewalls that establish truly shared protection and cohesion for the [EU’s] common ‘single currency.’” Without doubt, the rescue of Spain is the “acid test for the euro, and must be understood as the beginning of an ambitious series of mechanisms for common assistance and commitment, not just as an isolated case.”