Spanish Prime Minister Mariano Rajoy may be enjoying the European Central Bank’s emergency funds too much for Mario Draghi’s comfort.
Rajoy’s loosening of a pledge to cut Spain’s deficit within days of the central bank’s latest three-year loan offering to banks has confronted the ECB president with just the behavior it wants to avoid. ECB officials are concerned the respite they have won for the region’s most vulnerable nations has eased pressure on them to address the budget shortfalls that first provoked the turmoil.
“There’s a moral hazard element to this,” Ken Wattret, chief European economist at BNP Paribas SA in London, said in a telephone interview. “The ECB is clearly worried that in some countries the lower the risk premium on sovereign debt, the less urgency there will be to make some changes.”
Spanish 10-year borrowing costs have fallen 63 basis points to 5.19 percent since the ECB’s measures were announced in December, providing what Rajoy described as a “great relief” as Spanish lenders’ central-bank borrowings surged to record levels. His defiance on the deficit presents the ECB with the same quandary it faced last year, when former Italian premier Silvio Berlusconi’s government backpedalled on austerity pledged in return for ECB purchases of the nation’s bonds.
Draghi, who instituted the three-year loan program a month after taking over from Jean-Claude Trichet, has stepped up calls on governments to use easier market conditions to strengthen economies. The Frankfurt-based central bank’s effort “needs to be complemented by the work of national policy makers,” he said on March 13.
ECB Executive Board member Jose Manuel Gonzalez-Paramo, a Spaniard, said on March 5 that “the relative calm” achieved by the central bank “will not be durable if it serves as a pretext for national governments to relax their efforts now.” Governing Council member Erkki Liikanen has also urged governments to use the lull to fix their economies.
It’s “important that no country creates negative surprises,” said Liikanen, who heads the central bank in Finland, one of six euro-region countries still rated AAA. He spoke in a March 15 interview.
Those comments follow a battle between Spain and its euro-region partners over the size of deficit it should aim for. On March 2, the same day European leaders signed up to a tighter set of budget rules, Rajoy announced his government would target a shortfall of 5.8 percent of gross domestic product this year, instead of the 4.4 percent agreed previously. That was scaled back to 5.3 percent after finance ministers drafted a specific statement on Spain following a late-night meeting on March 12.
Rajoy’s move pushed Spanish borrowing costs above those of Italy for the first time in six months. Spain enjoyed lower bond yields than Italy since the ECB started buying both countries’ debt in August, when Italian lawmakers then weakened a 45 billion-euro ($59 billion) austerity program that Berlusconi’s government said was aimed at satisfying ECB demands.
Spanish 10-year borrowing costs were 5.19 percent at 10:23 a.m. Lonton time today, 38 basis points more than Italian yields and 317 basis points more than equivalent German securities. The spread over German yields compares with a record of 503 basis points reached on Nov. 18.
Spain’s looser deficit target does make sense in an economy that the government expects will shrink 1.7 percent this year, said Sebastian Paris Horvitz, chief market strategist at HSBC Private Bank Suisse SA in Geneva.
It is “less bad news on the growth front,” and indicates that “everybody is aware that there is a level of austerity that goes against the final goal of bringing back fiscal soundness,” he said. The ECB’s action has also “avoided a meltdown in Europe’s financial system.”
The 3 percent deficit target that remains in place for next year is a “stern challenge” that may “condemn Spain to another full-year economic contraction in 2013,” said Raj Badiani, an economist at IHS Global Insight in London. The gap was 8.5 percent in 2011, wider than the 6 percent target set by the Socialist government that handed over to Rajoy in December.
Spain’s ruling People’s Party is studying scrapping some tax deductions and accelerating payments in preparation for the 2012 budget to be presented on March 30, El Pais reported yesterday, citing unnamed officials at the Budget Ministry.
The success of the ECB three-year loan program and its focus on banks has blunted officials’ bargaining power to prevent governments such as Rajoy’s from backtracking on pledges, BNP Paribas economist Wattret said. The ECB’s earlier policy of buying struggling nations’ bonds gave it “wiggle room” to hold off purchases, he said.
The ECB previously stood by as Italy’s borrowing costs surged to records, only intervening after Berlusconi’s government fell. Purchases of government securities fell by half in the week that Berlusconi quit as prime minister. He resigned on Nov. 12, to be replaced by current premier Mario Monti.
“If the banks want the money, they get the money irrespective of whether the governments deliver or not,” Wattret said. “The moral hazard associated with it is a bit more problematic.”
Spain’s banks actively sought and lapped up ECB cash. Francisco Gonzalez, chairman of Banco Bilbao Vizcaya Argentaria SA, the nation’s second-largest bank, urged the central bank in November to offer loans of about three years, saying such a measure would allow lenders to support government debt.
Spanish banks increased holdings of the nation’s bonds to 202 billion euros in December, from 178 billion euros in November, Treasury data show. They borrowed 152 billion euros from the ECB in February, three times as much as they were taking a year ago.
Rajoy’s government will remain under pressure to meet its commitments particularly because it is a test case for the European Union’s new budget guidelines, aimed to enhance the credibility of the euro, said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc.
“There’s an unwritten rule that if you play by the rules you get support,” he said in a telephone interview. “If Spain comes out as a less good student, the ECB is not going to be in any easy position.”