Key political risks to watch in Spain

 

Spain's austerity measures, including wage cuts, pension freezes, the axing of welfare payments and the cancellation of state-funded infrastructure contracts, continue to weigh on growth expectations.

The Spanish economy emerged from more than a year and a half of recession in the first quarter, but few economists believe it will last and many expect Gross Domestic Product to be shrinking again before the end of 2010. Any growth could remain soft for a long time to come, as Spain has been left uncompetitive after a decade of above-average inflation, indexed wage hikes and high levels of household and corporate debt.

An overhaul of labour laws, seen as key to reducing 20 percent unemployment and improving competitiveness, has not gone far enough, according to opposition parties.

The country has avoided a Greek-style debt crisis, but concerns over the health of the euro zone's peripheral economies continue to weigh on investor confidence. Bond spreads, at double the levels recorded in April, are raising financing costs.

Following are some of the key factors to watch:

LOSS OF CONFIDENCE IN GOVERNMENT

Prime Minister Jose Luis Rodriguez Zapatero's hold on his Socialist party is still firm and calls from the main opposition party for him to step down have cooled, for now.

However, the Socialists struggled to pass key reforms needed to get the economy motoring again and have lost their once tight relationship with labour unions.

The government squeezed its austerity plan through parliament in May by only one vote. In June, labour reform passed only because opposition parties abstained en masse.

Zapatero faces a tough test in the autumn when he tries to cut spending further in the 2011 budget. Parliament could potentially reject the budget and force an early election.

Polls show the Socialists, whose term is up in 2012, trailing the opposition by about 10 percentage points in an early election scenario.

What to watch:

- Signs the government can no longer count on the support of key minority parties, such as Catalan nationalists Convergencia i Unio (CiU) and the Basque Nationalist Party (PNV).

- Any criticism of Zapatero from within his own party.

DEFICIT CUTS FALL SHORT

Investors will keep a close eye on the government's pledge to slash the public deficit to the European Union guideline of 3 percent of GDP by 2013, from 11.2 percent in 2009.

Some analysts say measures have not gone far enough - including a 15-billion-euro austerity plan announced in May on top of earlier cuts, and tax hikes such as July's rise of two percentage points in value-added tax.

At the same time, austerity will be a drag on economic recovery and could prompt a double-dip recession.

Official forecasts, considered optimistic, see an economic contraction of 0.3 percent in 2010 followed by a 1.3 percent expansion in 2011.

If growth remains weak, tax revenues will be lower than expected and higher social spending will make the fiscal targets hard to reach.

However, Spain faces less immediate pressure than Greece over its financing needs as its public debt-to-GDP ratio is one of the lowest among OECD countries at 55.2 percent in 2009.

What to watch:

- Will public opinion oppose more spending cuts? Spain's autonomous regions, which account for around half of the country's budget, will also be key.

- Any further move by ratings agencies to lower their outlooks on Spain. On July 1, Moody's said it was reviewing Spain's sovereign debt rating and may lower it by as much as two notches. On April 28 Standard and Poor's downgraded Spain's credit rating and on May 28 Fitch did the same.

The spread between Spanish government bonds and euro zone benchmark bunds hit a record high of 238 basis points in June, way up on the 75 bps level seen in April, though it has since dropped back to around 140 bps.

- Spain has had no difficulties so far in placing debt, but 10-year bono yields have risen to over 4.8 percent in recent auctions, from around 3.8 percent in March.

- The government is due to restart talks under the Toledo Pact towards a pension reform that would attempt to delay the retirement age.

UNIONS

Unions have called a general strike for Sept. 29 to protest austerity and the labour reform. It is not yet clear how widespread the strike will be. Unions represent only 16 percent of the workforce.

What to watch:

- Investors are unconvinced the labour market reform can have any meaningful short-term effect on the economy, even considering new amendments in the works in parliament.

Economists say the reform failed to tackle the key issue of collective bargaining, whereby companies are forced to make wage agreements across entire business sectors.

- The Sept. 29 strike will coincide with other protests throughout Europe, and could be a key test of the depth of feeling against austerity plans. Earlier strikes in Spain have not been debilitating.

UNEMPLOYMENT KEEPS RISING

The unemployment rate rose for a 12th consecutive quarter between April and June, fuelling concerns of a fall back into recession before the end of the year. The rate of 20.09 percent was the highest since 1997 and analysts see it rising further.

What to watch:

- Any significant rise in the jobless rate above 20 percent will force the government to spend more on unemployment benefits, reduce consumer spending and make it harder for the government to push through further austerity measures.

REGIONAL BANK RESTRUCTURING

Spain's restructuring of its banking sector has so far cost about 11 billion euros and was partly state-funded, reducing the number of savings banks to 19 from 45 through mergers and takeovers. However, concerns linger that Spain's banks remain excessively exposed to falling property values.

A new law allows the savings banks to open up to half of their capital to private investors in an effort to make them more transparent and self-sufficient.

In Europe-wide bank stress tests, published on July 23, in which 95 percent of Spain's banking system was included, five savings banks failed the severe downturn scenario and the central bank said the system would need an additional 1.835 billion euros to recapitalise.