Spain’s Debt Battle Intensifies as Valencia Test Looms

Spain Debt Fight Intensifies as Valencia Test Looms
Visitors pass fishing rods placed on the beach near the commercial port at Playa de las Arenas in Valencia, Spain. Photographer: Denis Doyle/Bloomberg

Spanish Prime Minister Mariano Rajoy’s bid to fight off the European debt crisis is about to intensify as his government wields new powers to tame the country’s indebted regions.

Regional officials from Rajoy’s People’s Party will today face their first attempt to persuade Budget Minister Cristobal Montoro that Valencia, which accounts for 10 percent of the Spanish economy, can avoid default without intervention. Deficits beyond the grasp of Madrid helped push the nation’s 10-year bond yields to a five-month high of 6.5 percent yesterday.

The collapse of regional finances is pushing Rajoy to reverse 35 years of devolution that saw public spending soar for projects in Valencia such as Formula One racing events and a new opera house. The European Union predicted last week that Spain will miss deficit-reduction goals this year and in 2013.

“Valencia will be the focus because of its size and importance,” Jose Carlos Diez, chief economist at Madrid-based brokerage Intermoney SA, said in an interview. “There is a lot of pressure from Brussels and the ratings agencies, and they need to give a signal.”

The regions were mainly responsible for Spain’s budget slippage last year as they missed their deficit target by more than 100 percent. Rajoy said May 8 he’ll intervene if necessary and told administrations to halve their shortfall this year to 1.5 percent of gross domestic product.

Spain’s borrowing costs rose at an auction of sovereign debt today. The government paid 4.876 percent on bonds maturing in July 2015 compared with 4.037 percent when they were last sold two weeks ago.

Rising Rates

The yield on Spain’s 10-year benchmark bond has risen 1.5 percentage points since March as investors doubted Rajoy’s ability to curb the deficit. The rate is approaching the 7 percent level that pushed Greece, Ireland and Portugal to seek rescue funds from the European Union and International Monetary Fund.

Rajoy has won powers to rein in deficits. A law passed last month sets out a road map that starts with today’s meeting at which regions presenting budgets to fit national policies and, nine months later, allows Madrid officials to impose cuts and tax increases.

The northern region of Asturias, accounting for 2.2 percent of economic output, also is at risk of intervention as an impasse leaves representatives unable to form a government to deliver spending cuts.

Regional finances are “a black box that always yields bad surprises when you open it,” ECB Executive Board member Jose Manuel Gonzalez-Paramo, a Spaniard, said on April 24.

Electricity Shutdown

The challenge Valencia poses for Rajoy is both political and economic. While indebted regions like Castilla La Mancha were Socialist fiefdoms, Rajoy’s party has run Valencia for 17 years.

Valencia’s 400 million euros ($509 million) of 5.5 percent April 2013 bonds yielded 16.6346 percent today, according to Bloomberg trader bid prices. That’s almost double the 8.9223 percent yield on two-year bonds issued by Portugal, which was rescued last year by the EU and IMF.

Power Cut

In Valencia, the regional capital, the effects are evident. The city hall’s power was cut off in February because of unpaid bills and garbage is piling up in the streets of the Cabanyal neighborhood. Ballester Fandos elementary school ran out of paper and other teaching materials after funding dried up for eight months, Principal Vicent Ripoll said in an interview.

“We’ve never seen anything like this,” Ripoll said. “This is due to the bad management of politicians who didn’t anticipate the crisis.”

Compounding Rajoy’s predicament, seven former Valencian PP officials were named as suspects last year in a bribery probe, according to a court spokeswoman who declined to be identified. They may be accused of using public money to overpay for services from businessmen they were close to between 2005 and 2009, according to a July court ruling.

A party spokeswoman in Valencia who asked not to be named declined to comment on the investigation.

Valencia’s sun-drenched beaches along the Mediterranean coast and the free-market policies of its government made it the epicenter of the boom that propelled Spain’s economy for almost a decade. Local developer Enrique Banuelos saw his company Astroc Mediterraneo SA surge tenfold in its 2006 initial public offering before the real estate collapse shriveled its value and left the region with thousands of empty seaside holiday homes.

Formula One

Spain’s third-largest city spent about 2.4 billion euros hosting the America’s Cup in 2007 as well as Formula One races. Officials hired local architect-turned international superstar Santiago Calatrava to build an avant-garde opera house in a dried up river bed. The project’s costs tripled, according to Joan Calabuig, a spokesman for the Socialist group in city hall.

Now a budget hole is forcing regional President Alberto Fabra to cut benefits, investment and wages to reduce a deficit that totaled 3.68 percent of GDP last year. He leads Spain’s second most-indebted region after Catalonia, with a debt load at 19.9 percent of GDP.

Valencia, rated junk by Standard & Poor’s and Moody’s Investors Service, tapped state-owned credit institute ICO for a 1 billion-euro credit line in February and wants another 1.68 billion-euro loan for bond redemptions this month of 1.47 billion euros. Fabra is seeking another 4.2 billion euros of syndicated loans to repay over 10,000 suppliers.

“‘The PP won big electoral victories when we were living in a delirious bubble,’’ Calabuig said. ‘‘Now the show is over.’’

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