European Central Bank President Mario Draghi’s plan to save the euro is about to have a test run. Spanish Prime Minister Mariano Rajoy appears ready to accept—not immediately, but soon—Draghi’s offer of a deal in which the bank would buy up Spanish debt in exchange for austerity and economic reforms.
It’s becoming clear, though, that Europe’s fourth-largest economy is in worse shape than people previously thought—and ECB bond buying won’t fix it. On Oct. 2, Madrid reported that unemployment rose in September for a second month, to 24.6 percent, despite earlier government assurances that joblessness had peaked.
Spain has said that its budget deficit this year will reach a higher-than-predicted 7.4 percent of gross domestic product, as it aids stricken banks, power companies, and regional governments. Capital flight is increasing, and most economists regard the government’s growth forecasts as wildly optimistic. “All Spanish macro indicators are flashing red,” says Thomas Costerg, an economist at Standard Chartered Bank. “You need to bring back growth, and this is something the ECB cannot do.”
Rajoy said at an Oct. 2 press conference that a bailout was not imminent. But his government approved a budget on Sept. 27 that closely tracks the austerity and structural reform measures its European neighbors have demanded. By setting the terms himself, Rajoy could spare Spain the humiliation suffered by Greece and other countries where outsiders dictated bailout requirements. Rajoy may delay a bailout announcement to avoid hurting his party’s chances in regional elections on Oct. 21.
No question, a big dose of ECB bond buying would make things easier for Madrid. Spain’s debt costs have spiraled as yields on its benchmark bonds spiked above 6 percent this summer. While borrowing costs have since eased to about 5.7 percent, the government “may only have enough cash to cover its deficit and bond redemptions through the end of October,” says Ricardo Santos, an economist at BNP Paribas.
A bigger question is whether austerity is what Spain needs. Greece ran up unmanageable debts because of a bloated public sector and poor tax collection. Spain’s problem “is not fiscal profligacy,” says Martin van Vliet, an economist at ING Bank. Its woes started in the private sector, where the collapse of a housing boom devastated the tax base and forced a rescue of the banks. Before the housing crisis, Spain had relatively little debt and ran modest budget deficits. ECB bond buying would prevent things from worsening, van Vliet says, “but it won’t kick-start the economy.”
Euro-zone governments in July offered Spanish banks a bailout of as much as €100 billion ($129 billion). Now even that may be in doubt. An independent stress test by consulting group Oliver Wyman put the banks’ capital shortfall at less than €60 billion. Within days, Moody’s Investors Service estimated that Spanish banks faced a capital shortfall of as much as €105 billion, almost twice the total just reported by Wyman. At the same time, the finance ministers of Germany, the Netherlands, and Finland are saying the aid will only be disbursed if it’s used for banks’ future financing needs, not for cleaning up troubled “legacy” assets on their balance sheets.
Fudged promises, dubious math, and a deepening recession make for a gloomy scenario. When Draghi announced the bond-buying plan in July, the ECB chief promised to do “whatever it takes” to save the euro and added, “Believe me, it will be enough.” Spain may show whether he was right.