Spain seeks to restore calm after S&P downgrade

 

European leaders will seek to restore market calm this week after Spain was cut by Standard & Poor's and a German-led austerity agenda to resolve the debt crisis came under fire ahead of elections in France and Greece.

With Spain's largest unions leading marches involving thousands of protesters in 55 cities yesterday, Prime Minister Mariano Rajoy's government battled to prevent Spain from becoming the next country to seek bailout aid. In France, the final round of presidential elections on May 6 and the prospect of victory for Socialist candidate Francois Hollande steered debate toward whether a focus on budget cuts worsens the crisis.

"Watching Spain now is exactly like watching Ireland around October 2010 before Ireland was forced into its bailout," Megan Greene, a senior economist at Roubini Global Economics LLC, told Bloomberg Television's "Street Smart" on April 27. "The government can't win no matter what it does."

As Spanish unemployment last week reached almost one in four of the working-age population, Hollande demanded that euro- area leaders move to promoting growth from cutting budgets, as agreed by 25 European governments in the so-called fiscal pact. German Chancellor Angela Merkel drew the line at re-opening talks on the fiscal treaty, though she said growth could be boosted with labor-market reform and European Union funding.

"There will be no new negotiations on the fiscal pact," Merkel told the Leipziger Volkszeitung in an interview published on April 28. Even so, EU leaders may consider measures such as strengthening the European Investment Bank as part of a package of growth initiatives to be discussed at their summit meeting in June, she said.

‘Years Rather Than Months'

The debate was spurred on by European Central Bank President Mario Draghi last week after he called for a "growth compact" consisting of structural changes and improvements in competitiveness to enhance the fiscal pact.

"If the conversation has shifted toward this, then it shows that they're moving toward a way to put their economy and their currency on a more stable footing," William Adams, a senior international economist at PNC Bank NA, said in an interview from Pittsburgh. "It's a process you're going to measure in years rather than months."

The EU is working on an investment package of €200 billion euros for infrastructure, renewable energy and technology in the euro-area's worst-hit countries, El Pais newspaper reported, citing unidentified officials familiar with the plan. The funds will come from 12 billion euros from the European Financial Stabilisation Mechanism to boost the capital of the EIB, El Pais said.

‘New Focus on Growth'

A war of words erupted last week between Hollande, who decried Germany's fiscal-focused leadership in the two-year-old financial crisis, and Merkel, who said that the turmoil can't be resolved without cutting debt. Polls show that Hollande is likely to succeed Nicolas Sarkozy as France's next president after winning the first round of voting April 22.

"You, the French people, are going to vote to give Europe a new focus on growth, on progress, on the future," Hollande told 17,000 campaign supporters yesterday in Paris. "The head of the ECB can also see that some government heads also understand that austerity alone won't help cut debt. They are starting to hear what we are saying," he said.

Greece will also hold elections on May 6, with polls indicating no party will win enough votes for a parliamentary majority. The lack of a clear mandate could complicate Greek bailout efforts, since the new government must spell out to global creditors in June how it will make fresh budget cuts.

Spanish Yields Rise

Spain figured at the center of last week's debate, with borrowing costs climbing after S&P cut the kingdom's sovereign credit rating for the second time this year, to BBB+ from A, on concern about further fiscal tightening and the country's banks.

Spain's 10-year yield climbed as high as 6 percent April 27, bringing the gain this year to almost a percentage point.

Roubini's Greene said that concerns on Spanish debt were self-sustaining as markets gyrated from worries about the effects of more austerity to a lack of budget discipline. She predicted Spain would seek bailout aid early next year.

"Yields rise and the Spanish government announces further austerity measures - the markets freak out because they worry about the impact of those austerity measures on growth," Green told Bloomberg. "If the Spanish government doesn't announce austerity measures, the markets don't think that the Spanish government is serious about reining in its fiscal dynamics."

Bank Recapitalization

The Bank of Spain said April 23 that the economy shrank by 0.4% in Q1, tipping the nation into its second recession since 2009. Rajoy in March scrapped Spain's aim to cut its budget deficit to 4.4% of output this year after a slumping economy threw the nation's ambition to consolidate its finances off course.

As Spain pushes through the deepest budget cuts in at least three decades, the country's banks probably need €50 billion in capital, according to Morgan Stanley estimates.

Protesters in Madrid yesterday filled the city's Puerta del Sol square despite the rain, with placards reading "No bread, no peace." The protests follow a report last week showing that Spain's unemployment rate rose to 24.4% in Q1, the highest level in 18 years.