30 Mar 2012

Spain: the Brussels budget ‘suicide pact’

In Seville the locals are preparing for Semana Santa, the normally raucous Easter celebrations. But this year it isn’t just rain threatening the parades. Andalusia is now the epicentre of concern within the Eurozone’s biggest headache. The highest unemployment is here, and the strongest political voice against massive one year €27bn cuts announced in Madrid (well actually announced to eurozone finance ministers in Copenhagen first) today: is also here.

Spain is on the euro knife edge (remember its public debt levels are low compared with other bailed out countries). Prime minister Rajoy’s decision to unilaterally increase Spain’s debt target on the same day as signing the EU’s supposedly robust new fiscal compact went down rather badly in the markets. Spain’s borrowing costs have crept up, above Italy’s, heading towards 6 per cent. The honeymoon offered to the new Spanish government by bond traders stopped abruptly. Markets started to notice that Spanish banks were the biggest customer of Mario Draghi’s cheap three year loans. Half of Spain is probably parked somewhere on a dark corner of the ECB’s balance sheet. As a result his government’s room for manoeuvre was limited.

On the face of it, a one year budget cut of €27bn, including an immediate 17 per cent cut to Spanish government departmental spending, is brutal, compared for example to the UK’s spending cuts. But the tax rises sound a little sketchy. No VAT rise, for example, unlike Britain. A hefty amount is expected to be raised from offering Spain’s tax evaders a one off amnesty if they pay 10 per cent of their bill. You could see that as €3bn gained (really) or the entire cost of the fiscal adjustment lost. Either way I think Spain’s indignados stopped being merely indignant, and just got very angry.

Luis Garicano, the Spanish LSE economist, and leading Spanish language econoblogger, told me that there were reasons to be optimistic about Spain, but yes the cuts were a type of Brussels-inspired “suicide pact”. Spain was heading for its worst economic year since the war, with unemployment rising to six million, and the people were “starting to feel demoralised”.

Make no mistake, to inflict numerical statistical austerity on a country with mass unemployment and already in recession is shock therapy that I cannot remember for an industrialised nation. The mood here is darkening. Old social splits seem to be re-emerging. The young are hankering after emigration, expecting to stay with their parents until their 40s. Older workers are terrified of being fired. Such sharp cuts surely makes Spain the ultimate laboratory for what is an economic experiment.

I have my doubts that it can work.

Follow Faisal on Twitter: @faisalislam