Zapatero Races to Woo Basques, Bond Market as Budget Looms

Prime Minister Jose Luis Rodriguez Zapatero has three weeks to draft a budget that can unite Basques who want to split from Spain and investors skeptical he can tame the euro region’s third-largest budget deficit.

Zapatero’s minority administration, which plans to announce its tax and spending plans by Sept. 30, still hasn’t cobbled together enough parliamentary support for the biggest round of cuts in three decades. Adding to his challenges, the budget will come as unions stage their first general strike since 2002.

Zapatero, 50, is trying to hammer out a spending plan as investors’ concerns about Europe’s finances resurface four months after the European Union agreed a rescue package for the bloc. Zapatero is dependent on the Basque Nationalist Party’s six votes to get his plans through parliament and buy enough time to make it through to the end of his term in 2012. Failure might topple his government.

“The situation is pretty delicate,” said Alfredo Pastor, former deputy finance minister and a professor at IESE business school in Barcelona. “If they don’t pass the budget, the only solution would be to dissolve parliament and have elections.”

Investors are putting European governments under renewed scrutiny. The extra yield that investors demand to hold Spanish 10-year debt over German bunds surged 47 basis points from July 27 to a one-week high of 185 basis points yesterday, before easing to 173 basis points today. It hit a euro-era high of 221 points on June 16.

Photographer: Tomohiro Ohsumi/Bloomberg

Jose Luis Rodriguez Zapatero, Spain's prime minister. Close

Jose Luis Rodriguez Zapatero, Spain's prime minister.

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Photographer: Tomohiro Ohsumi/Bloomberg

Jose Luis Rodriguez Zapatero, Spain's prime minister.

Political Risk

The spreads on Irish and Portuguese debt climbed yesterday to the highest since at least 1997, before narrowing to 365 basis points and 349 basis points respectively today. In Belgium, which still doesn’t have a government 2 1/2 months after inconclusive elections, the spread on its 10-year bonds hit the highest level since July yesterday and stood at 71.9 basis points today.

“Political risk for the periphery, Spain included, is one of the biggest risks” to the euro region, said Phyllis Reed, head of bond research in London at Kleinwort Benson Private Bank, which manages about $32 billion and holds no Spanish debt.

Zapatero’s Socialists, seven short of a majority in the 350-seat assembly, are seeking the support of the six lawmakers in the Basque PNV party which, combined with abstentions from one other group, would be enough to pass the budget. The PNV is so far refusing to publicly acknowledge the national ramifications of its position.

“We’re somewhat surprised to see people saying the Basque Nationalist Party is responsible for whether Zapatero falls or not,” PNV Chairman Inigo Urkullu told state radio RNE on Sept. 7. He left the door open to early elections, saying Zapatero has another year in office “unless events are brought forward.”

Skillful

The Socialists still have time to find a majority for the budget, said Alejandro Quiroga, author of three books on Spanish politics. Zapatero has run a minority government since 2004, forging agreements across the political spectrum to pass legislation. The PNV supported Zapatero’s last budget after initially shunning the Socialists.

“He’s always been able to manage some kind of deal,” said Quiroga, a senior lecturer in politics and history at Newcastle University in northeast England. “He’s very skillful.”

Pastor said the spending plan will probably be passed, though with “rather large concessions” for the Basques, who will push for more economic autonomy from Madrid. He served under Felipe Gonzalez, Spain’s longest-serving prime minister, whose government fell in 1995 after failing to pass a budget.

Slump

Europe’s fiscal crisis and Spain’s worst economic slump in 60 years have made it harder for the Socialists to form alliances as they have lost the support of parties that define themselves as leftist without winning over more pro-business lawmakers. That left the Socialists with a margin of one vote to pass a 5 percent public-wage cut and a freeze on pensions on May 27, fueling calls for early elections from the main opposition People’s Party and Catalan party CiU.

While Spanish law allows governments to roll over the existing budget for another year if the new one isn’t approved, failure to pass the budget traditionally means early elections.

“It’s almost impossible to imagine anything but early elections” should parliament throw out the budget, Carlos Solchaga, finance minister from 1985 to 1993, said in an interview.

That would increase the risk premium on Spanish debt, said Harvinder Sian, a senior bond strategist at Royal Bank of Scotland Group Plc in London.

“If the government does fall, that would be a very big statement for the market and you would see some weakness,” he said.

Early Election

An early election would hand victory to the pro-business People’s Party, according to a poll on Sept. 5 commissioned by newspaper El Pais. It gave the PP an 8.9 percentage-point lead over the Socialists, which had 32.9 percent support.

On the budget, Zapatero’s room for maneuver has narrowed since August, when borrowing costs were falling so fast that he said the government could reverse some spending cuts. The spread widened 35 basis points in the four days after his comments.

“You’ve seen some pullback from the austerity measures that were announced at the height of the crisis, which doesn’t go down particularly well,” Sian said. “Things are very fragile still.”

The government hasn’t given details on the budget except to say it may raise tax on the wealthy. That may aim to pacify unions planning a general strike on Sept. 29, the first such walkout against Zapatero, a union member who said in 2005 he slept with his membership card by his bed.

The two largest unions oppose the budget cuts and changes to labor laws. Those measures have also riled traditional allies in parliament, making the government reliant on the PNV.

“The climate’s not easy but there will be a deal,” said Juan Manuel Eguiagaray, a former Socialist minister from 1991 to 1996 and head of research at the Fundacion Alternativas institute in Madrid. “It’s not in anyone’s interests to have elections now.”

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

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