Spain Unveils New Set of Overhauls

September 27, 2012

MADRID—The Spanish government on Thursday unveiled a package of regulatory overhauls, tax increases and spending cuts for 2013, gaining a short-term market reprieve as concerns mount over Prime Minister Mariano Rajoy’s ability to stabilize the euro zone’s fourth-largest economy.

Spending will actually rise by 5.6% under the new measures, which include €13 billion ($16.7 billion) of tax increases and spending cuts. The spending increase is largely the result of a 34% rise in debt-servicing costs, as the government shied away from making some politically difficult spending cuts.

Even as the country considers a request for European assistance, Mr. Rajoy faced new political challenges on Thursday, as Catalonia, the country’s second-most populous region and the biggest contributor to the national economy, called for a referendum on independence.

The Spanish economy will be under close scrutiny this week when it publishes the results of bank stress tests and sets out further overhauls to the economy. Dow Jones’s Geoffrey Smith examines the possible outcomes. Photo: Reuters

That followed antiausterity protests in Madrid’s center this week that turned violent for the first time. Several other European Union countries also cast doubt this week on whether Spain would be able to shift the financial burden of its EU banking aid to regional bailout funds, as it had hoped.

Spain’s borrowing costs, as measured by the yield on its 10-year government bond, have been hovering at around 6%, a level seen as unsustainable in the long term, making it more likely the central government will have to ask for European assistance to meet its financing needs.

A favorable market reaction to the planned measures may buy Madrid some more time on the bailout front.

The euro rose to $1.291 Thursday, from $1.2868 late Wednesday, after Spain outlined the measures.

The yield on Spain’s 10-year sovereign bond fell 0.11 point to 5.966%, according to Tradeweb. U.S. equity markets gained ground.

Speaking at a news conference after the government’s weekly cabinet meeting, Finance Minister Luis de Guindos said the government continues to study the possibility of an aid request.

“The government is in contact with the countries involved…to see what the different possibilities are and how they would work,” he said.

Some analysts said Thursday’s measures from Madrid represent an attempt to buy time to negotiate the terms of a bailout while laying the groundwork for a request when it becomes necessary.

Sassan Ghahramani, an adviser to hedge funds and asset managers, said investors were likely cheered by evidence that Spain is making progress toward making an aid request, something they believe is inevitable.

“Markets, what they see is that this will allow the government to request a bailout without further conditions,” Mr. Ghahramani said.

Madrid promised to implement a long list of EU policy recommendations, including the elimination of overlapping regulations set by different levels of government, further loosening of rigid labor laws and placing limits on early retirement.

It also promised to set up an independent agency to monitor budget policy and to offer new tax incentives for small businesses.

The European Commission, the EU’s executive arm, applauded the measures.

“The reforms are clearly targeted at some of the most pressing policy challenges,” Olli Rehn, commissioner for economic and monetary affairs, said Thursday.

Some of Madrid’s budget measures, on the other hand, met with a bit more skepticism.

The government said, for example, that it would raise pensions by 1%, ignoring EU advice that they be frozen or reduced.

The government announced a series of new revenue measures, which, together with a value-added-tax increase presented in July, help to compensate for the soaring interest bill. Madrid announced, for example, a 20% tax on lottery winnings.

Many analysts say they believe that the government’s effort to lower a budget deficit that stood at 9% of gross domestic product in 2011 to below the 3%-of-GDP limit for EU countries by 2014 has gone off track because of a deep recession.

Madrid aims to lower its budget deficit to 4.5% of GDP in 2013 and to 2.8% in 2014.

“Spain will miss the deficit-to-GDP targets for 2013 and 2014,” said Stephen Pope, managing partner at consultancy Spotlight Ideas.

In addition, Spain’s new austerity budget, plus the announcement it will take around €3 billion from the state’s pension reserve fund, could spark a new political backlash toward the government.

“This will be the budget of [economic] depression,” said Inmaculada Rodríguez Piñeiro, spokeswoman for Spain’s largest opposition party.

“This is the first time the government uses the pensions fund,” she said, adding that her Socialist party will oppose the effort.

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