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Spain Risks Deficit Spiral as Poll Postpones Cuts: Euro Credit

Spain's Prime Minister Mariano Rajoy
Spain's Prime Minister Mariano Rajoy. Photographer: Denis Doyle/Bloomberg

Spain’s month-old government may postpone deeper budget cuts until after a regional election in March, adding to the risk the nation misses its deficit goal for the second year.

The ruling People’s Party, led by Prime Minister Mariano Rajoy, will contest an election in the southern region of Andalusia to end 30 years of Socialist rule. Spain’s 10-year bond yields have risen 10 basis points to 5.5 percent since the PP government took over on Dec. 21, increasing the rate to 359 basis points more than German bunds of similar maturity.

“Rajoy doesn’t want to get burnt before the Andalusian election,” Antonio Barroso, an analyst at Eurasia and a former Spanish government pollster, said in a telephone interview. “They’re so crucial for the PP that it won’t take any kind of measure that would undermine its ratings in the region.”

Rajoy needs to slice the equivalent of 3.6 percent of gross domestic product off the budget deficit this year to meet a European Union target, just as the economy may be entering its second recession in two years. Postponing steps until after the March 25 election risks undermining confidence in Spain’s ability to meet its goal, which Fitch Ratings already has “doubts” the country will reach.

“Rajoy has yet to explain how he will reduce the deficit when the economy is shrinking,” said Georg Grodzki, global head of credit research at London-based Legal & General Investment Management, which oversees about $515 billion. “I don’t think Spain can afford to wait for more than two months at the most.”

High Earners

After its second Cabinet meeting on Dec. 30, the PP, which defines itself as pro-business and opposes higher taxes, announced 15 billion euros ($19 billion) of budget cuts and spending of 1.4 billion euros to raise pensions. It increased income taxes and created a new bracket for those earning more than 300,000 euros a year, breaking an election pledge and adopting a Socialist proposal for greater levies on the wealthy.

Budget Minister Cristobal Montoro, who is a member of parliament for the Andalusian city of Seville, said the government was asking people “to make a contribution proportional to their economic ability.”

Looser Target

Montoro called on the EU to ease Spain’s 2012 deficit target yesterday, saying the goal for this year was based on outdated growth forecasts. His comments to La Vanguardia newspaper, which a ministry spokeswoman confirmed, contrast with pledges by Deputy Minister Soraya Saenz de Santamaria and Economy Minister Luis de Guindos that the target must be met.

Spain’s economy may shrink 1.5 percent this year if the government meets its deficit goals “strictly,” the Bank of Spain estimated today. The economy contracted 0.3 percent in the fourth quarter from the previous three months, the Madrid-based central bank said.

Andalusia, which has been run by the Socialists since the autonomous regions were created1 in 1978, has the third-biggest economy after Catalonia and Madrid and is the second poorest as measured by GDP per capita. The unemployment rate is the highest in the country at 31 percent.

The PP controls 11 of the nation’s 17 regions and winning Andalusia would mean the PP or its allies govern the three largest districts. Rajoy and his ministers, including Montoro and the deputy prime minister, have been campaigning during the weekends in the region.

Target Missed

The states are crucial to Spain’s efforts to cut the budget deficit as they control more than 30 percent of public spending, hire half of all public workers, and use most of their budgets for health and education. Their failure to reduce spending last year was the main reason why the overall shortfall missed its target, according to Rajoy.

The government estimates the deficit was about 8 percent of GDP last year, more than the 6 percent targeted by the previous Socialist government. The 4.4 percent goal for 2012 was made by the former administration based on a growth forecast of 2.3 percent. Spain’s economy, which stagnated in the third quarter, is now in recession, Montoro said on Jan. 18.

“Spain may miss the deficit target if it doesn’t implement further fiscal measures,” said Fadi Zaher, a fixed-income strategist at Barclays Wealth in London. “The current target for Spain was set by the former government and was based on optimistic growth assumptions.”

Fitch Ratings, which has cut Spain twice since May 2010 and rates Spain AA-, has “doubts” about whether the country can meet the deficit target this year and next, Managing Director Edward Parker said in Madrid on Jan. 19. Citigroup Inc. estimates the deficit will amount to 5.6 percent of GDP this year and UniCredit SpA sees a shortfall of 6.5 percent.

Still, Rajoy pledges to stick to the target and his deputy, Saenz de Santamaria, said on Jan. 20 that the government is “determined” to meet its commitments and has the “will” to do so. The 2012 budget is due in Parliament at the end of March.

“The bulk of economic policy measures will come in March,” said Javier Del Rey Morato, a political communications professor at Madrid’s Complutense University. The government “hasn’t shown its hand yet,” he said.

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