Spain and the Long Hard Slog

Despite all the brouha over the bail out for Greece, the most pain from the Eurozone crisis is going to be felt elsewhere in the Mediterranean.  Spain doesn’t have the debt of Greece but it does have the highest unemployment and is set for the biggest cuts in government spending in the Eurozone.  And it is not going to be quick or easy with a weak economy made worse by fiscal cuts and trouble likely from its feckless regional government and agitation from a generation of youth out of work.

In terms of government debt, Spain looks like a model of virtue compared to many other countries in Europe.  Its government debt as a percentage of GDP was a mere 39.9% in 2008 before the Eurozone crisis and had only climbed up to 68.3% by 2011 which is lower than the supposedly virtuous Germans who have a government debt to GDP ratio of 82.6%. 

However, the budget deficit of the Spanish government has ballooned due to the effects of the global recession.  The initial effects on the Spanish economy was not as bad as elsewhere with a 3.7% decline in GDP in 2009 compared to the Eurozone average of a 4.3% drop.  But while 2010 saw a recovery in most European countries, the economy in Spain remained weak and GDP edged down by a further 0.1%.  Growth returned in 2011 but was limited to a 0.7% rise in GDP and all eyes had turned to Europe in the midst of its sovereign debt crisis.

What attracted the concern of investors to Spain was the combination of the sluggish economy and a rapidly expanding budget deficit.  The budget deficit hit 11.2% of GDP in 2009 and remained stubbornly high in the following years at 9.2% in 2010 and 8.5% in 2011.  Along with extra government spending for unemployment benefits and the like, government revenues dried up as two sectors which had benefitted from the boom before the crisis, construction and banking, fell into trouble. 

Now, the government has announced plans to implement savage austerity measures to lower the deficit to a target of 5.3% in 2012 and 3.0% in 2013.  While saving the country from a rise in the interest rates on government debt and the possibility of similar debt restructuring to Greece, the cuts to government spending will further weaken the economy and this may get Spain in even more trouble by creating a perverse spiral of government cutbacks and economic fallout.  Considering the lower level of government debt, a slower pace of budget cutting could be seen to be more appropriate but this is not something that the bond markets or Angela Merkel (among others) seem likely to allow.

Plans to cut the budget are also expected to run in trouble with protests already a common sight on Spanish streets.  Also, regional government controls a large part of government spending and won’t be happy to see spending cuts hit home on their turf.  So the stories in the papers have been whether the unprecedented 27 billion euros worth of budget cutting measures announced last month will be enough.  With a further 1.7% decline in GDP forecast for 2012, it is unclear whether the economy or the Spanish people can take much more.