When leaders of the 27 European Union nations gather in Brussels on Thursday for a two-day summit, all eyes will be on Spanish Prime Minister Mariano Rajoy. Will he officially ask for a financial bailout or not? Will he even give a clue as to whether he might ask for one? The issue has become the latest European guessing game, but it’s also shaping up as a big test of credibility for the euro zone and its crisis management.
Over the past month, financial market pressure on Spain and Italy has eased following approval of a €700 billion euro zone bailout fund, the European Stability Mechanism, and the declaration by the European Central Bank that it will ride to the rescue of countries that apply for a bailout by buying unlimited amounts of their sovereign bonds on the secondary market, if necessary, to counter market speculation.
Yet Spain’s public finances, in particular, are in poor shape. Its banks urgently need recapitalizing and it needs to repay more than €200 billion in sovereign borrowing next year. Many savvy investors believe Spain should ask its European partners for a bailout while the pressure is off. “He who hesitates is lost. Pride goeth before a fall,” Bill Gross, a well-known U.S. fund manager and investment guru, tweeted on Oct 11. “Spain should swallow its pride and ask for help now!”
But here’s the catch: to be eligible for a bailout under the newly agreed rules, a nation would have to implement a range of tough conditions set by E.U. officials and the International Monetary fund. Financially, it would be a boon; politically, it could be a humiliation. At the very least, it would be a loss of sovereignty — and face.
Rajoy has said that he would only take such a step if Spain had unanimous support from its partners and “if the conditions attached are reasonable.”
As it is, Rajoy is already under huge domestic pressure. Demonstrations have been taking place almost daily throughout Spain in protest against tough austerity measures. The economy is contracting painfully and there’s no let-up in sight. The IMF’s latest forecast, published Oct. 9, is for Spanish output to decline by 1.5% this year and by 1.3% in 2013, and for unemployment to remain at its stratospheric 25% level. That’s considerably more pessimistic than the IMF’s forecast last July.
Rajoy is also having to cope with restive regions, including Catalonia, whose finances are in bad shape but where deep spending cuts are proving particularly contentious politically. The northwestern region of Galicia, where Rajoy hails from, and the Basque country are both holding local elections on Oct. 21, which may alter the timing of any bailout decision. Polls show that Rajoy’s People’s Party may lose its absolute majority in the Galicia regional legislature.
On Monday, a Spanish finance ministry official briefed the international press off the record – and continued the cat-and-mouse game. He said the government was talking to its European partners about a possible bailout request but said there were concerns that such a move might destabilize Italy by shifting the attention of financial markets onto Rome’s problems. But he also gave the best reason for applying for help: it would, he reckoned, bring down Spain’s borrowing costs by 1.5 percentage points – in other words, closer to 4% than the current range around 6% – and spark a big stock market rally.
So what’s likely to happen Thursday and Friday in Brussels, other than a lot of intense conversations in corridors? The main agenda item is discussion of an interim report issued Oct 12 by Herman van Rompuy, the president of the European Council, about the missing elements and governance needed to shore up the single currency, and in particular the structures needed to create a new banking union. But as van Rompuy’s report acknowledges, the discussion this week is aimed at being a prelude to decisions to be taken at the next E.U. summit in December.
That’s not to say there won’t be controversy. One of van Rompuy’s suggestions is for a separate budget to be set up for the 17-nation eurozone that would run alongside the regular E.U. budget for all 27 members. “We have to do everything to stabilise the situation in the eurozone, and if a fiscal capacity or a separate budget can help and can contribute to this stability, then you have to reflect on it, to discuss it,” van Rompuy told a conference in Brussels. Creating such a separate budget would be highly symbolic because it would mark a schism within the E.U. and officially delineate a “two-speed Europe” that has been talked about for years.
The banking union plans aim to set up a single European banking supervisory system, likely housed at the European Central Bank, as well as a mechanism for dealing with failed banks and a deposit insurance scheme that would safeguard individual savers. So far only the supervisory aspect has been seriously discussed, and E.U. watchers are not expecting many developments this week – not least because of disagreements about whether governments or banks themselves should fund a deposit insurance scheme. The Dutch government has already said it sees van Rompuy’s report as “insufficient.” Bank of America Merrill Lynch, in a note to clients, says it expects only “snail’s pace progress” on the issue.