A man holds a doll depicting Spain's Prime Minister Mariano Rajoy with a placard reading "Mariano had a problem with the scissors" during a demonstration organized by unions in Barcelona on June 20, 2012
Spain got the green light from its E.U. partners last Friday for a $120 billion bailout of its troubled banks. The approval came in record time for the beleaguered euro zone, less than a month after Prime Minister Mariano Rajoy made a formal request for funds on June 25. The reaction of financial markets? A rout on the Madrid stock exchange and a big jump in the yields on Spanish government bonds, which soared to over 7%, a crisis level that is unsustainable.
What’s going on? The short answer is that the markets are switching their attention from the parlous state of Spanish banks, which have $192 billion in what the Bank of Spain calls “doubtful loans” on their books, or almost 9% of total lending, and are now focusing on the state’s finances, which are showing new signs of deterioration. That’s a worrying development for the euro zone as a whole, since the emergency bailout funds it has agreed on would barely cover a Greek-like sovereign rescue of an economy as big as Spain’s. The International Monetary Fund, in a new report on the euro zone issued on Friday, warns about “very high levels of stress” and is calling for “more determined action” to root out the causes of the crisis.
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But it’s hard to see how much more Rajoy’s government in Madrid can do by way of determined action. The government this month announced further massive budget cuts totaling $80 billion that will hit key sectors, including education and spending on public investment as well as unemployment benefits, in an effort to bring the budget deficit down to 3% of gross domestic product by 2014. This year, the deficit was supposed to drop to 4.8%, but Spain’s European partners earlier in the month gave it a little breathing space, allowing it to run a deficit of over 6%.
The cuts have sparked big street protests that continued over the weekend, raising the political pressure on Rajoy. Unemployment is over 20%, and morale is rock bottom; more than 40,000 Spaniards have left the country in the first six months of this year, according to the National Statistics Institute, up 44% from last year, and there is little sign of relief anytime soon: the Bank of Spain’s governor, Luis M. Linde, said last week that he now expects the economy to contract by 1.5% this year overall and only show very weak growth in 2013.
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Adding to its problems, the government faces some worrying new financial pressures from heavily indebted Spanish regional governments that are looking to Madrid for a bailout. The 17 autonomous regions are not able to tap international debt markets and so depend on money from central government, which has created a $22 billion emergency fund. But that may not be enough: on Friday, the Valencia region — which has been among the hardest hit after a lengthy debt-financed spending spree on real estate — said it needed to tap that fund, and other regions including Catalonia, Castilla La Mancha and Andalucia are expected to follow suit.
“The markets are doubting Spain,” Germany’s Finance Minister, Wolfgang Schäuble, told the Bundestag last week, before it voted overwhelmingly to back the Spanish bank-rescue package. He warned that even the appearance that Spain might have difficulty honoring its debt would have a very severe impact on the rest of the euro zone. So what happens next? It’s late July, the Olympics are coming, and Europeans, at least, are heading off to vacation. Spain — and its European partners — are hoping the markets will quiet down. A first tranche of the $120 billion bank-rescue money will be arriving in Spain later this month, which could help. But what’s sure is that every small piece of bad news out of Spain will set off fresh jitters. The fiesta is definitely over.