Rajoy Delay Marks Bet on Turmoil Making Bailout Terms Easier
Spanish Prime Minister Mariano Rajoy’s equivocation on seeking a European bailout amounts to a bet that another bout of market turmoil will enable him to broker better terms over German resistance.
In Rajoy’s thinking, “the worse it gets, the better for Spain,” said Jose Garcia-Montalvo, a former Harvard University economist who teaches at Pompeu Fabra University in Barcelona. “That would make the Germans think more deeply about the cost of letting the southern countries sink. But it’s a very risky strategy.”
Heading into a European Union summit in two days, Rajoy has brushed off pressure to reach for a lifeline from investors such as Pacific Investment Management Co.’s Bill Gross, who manages the world’s biggest bond fund. EU counterparts are divided. Germany is pushing back against prodding by France and Italy to exploit bond buying by the European Central Bank and counter a financial storm entering its fourth year.
Defending Spain is crucial because its economy doubles the output of Greece, Ireland, Portugal and Cyprus combined, testing the capacity of aid mechanisms. Its borrowing costs are a reference for Italy and even France, which has so far seen its yields contained even with unemployment at a euro-era record, the economy stagnant and its debt levels climbing.
Spanish 10-year bond yields rose 2 basis points to 5.84 percent at 11:55 a.m. even after the Treasury beat its target by selling 4.86 billion euros ($6.32 billion) of debt at an auction. Spain is ready to ask for aid and will wait for European partners to work out the sequencing of a request and its consequences for Italy, the Financial Times reported today, citing a senior economy ministry official.
Spanish bonds have rallied since the ECB announced its willingness to unleash unlimited firepower to defend struggling sovereigns. The gains have encouraged Rajoy to avoid triggering the aid as demonstrators and regional leaders step up protests against budget cuts. More austerity would probably be required to access the deal with euro governments demanded by the ECB.
Ten-year Spanish bonds yield are almost 200 basis points below the euro-era record of 7.75 percent on July 25, the day before ECB President Mario Draghi first said he’d do what it takes to preserve the euro. That compares to the 2011 average of 5.4 percent, providing Rajoy a window to stand pat.
In holding out, the Spanish leader is playing with fire, said Ebrahim Rahbari, an economist at Citigroup Inc. in London.
“If there’s something inevitable and painful it’s very rare that it pays off in a rational way to defer,” Rahbari said in a telephone interview. “If I was his adviser I’d strongly, strongly suggest changing tack.”
Stalling has been a tactic Rajoy has used with limited success. His People’s Party lost the regional election in Andalucia in March even after he delayed announcing unpopular measures until after the vote. Bond yields rose through the spring as he deflected pressure to set up a so-called bad bank to clean up the financial system.
His government’s first call for outside support for the financial system, contrasting with the routine denials that preceded it, came four days before a 100 billion-euro ($130 billion) bailout request on June 9 to prop up Spain’s banks.
Rajoy and the PP, who contest regional elections in Galicia and the Basque country on Oct. 21, may again seek to benefit from deferring or even dodging the stigma of a bailout.
The history of financial crises also suggests Spain may benefit from delay, according to Edwin Truman, a former U.S. official who monitored the Latin American crisis of the 1980s and the Asian meltdown of 1997-98 from the Federal Reserve. Countries requesting aid later in a crisis may win easier conditions because their needs are in part caused by spillover effects, he said.
“Broadly speaking one would think that the conditions would be somewhat less onerous,” Truman, now a fellow at the Peterson Institute in Washington, said in a telephone interview yesterday. “The Spanish situation is more caused by contagion and less caused by fundamental economic problems, though clearly it also has some fundamental problems.”
Should Rajoy make it through the end of the year, a deepening recession, the prospect of elections in Italy, or even a Greek exit from the euro could change the political dynamic, bolstering Spain’s negotiating position, according to Jonathan Loynes of Capital Economics in London.
“Spain could benefit because the rest of the region would say we have to do whatever we can to stop Spain getting forced out,” said chief European economist Loynes, who predicts Greece will leave the currency union within a year.
With borrowing needs of at least 207 billion euros next year, compared with 69 billion euros in the 2008 budget, Rajoy is likely to require aid, Loynes said.
Loynes said the 17-nation euro bloc’s output may contract as much as 2.5 percent next year. That’s the most pessimistic forecast in a Bloomberg survey of 63 economists. The median forecast was for a 0.3 percent expansion.
The prospect of a sovereign bailout bid from Spain is receding. Deputy Prime Minister Soraya Saenz de Santamaria said Oct. 5 the government had to be sure aid would “materialize” before asking for it, signaling doubts about German resistance.
German Finance Minister Wolfgang Schaeuble said Oct. 14 that Rajoy is “delivering” the reforms required and his country can’t subsidize the whole currency union.
Spain’s financial situation is deteriorating amid the bailout debate. Standard & Poor’s last week lowered its rating to BBB-, one step above junk. Moody’s Investors Service may become the first agency to strip the country of its investment grade when it announces the results of a review this month.
“Spain should swallow its pride and ask for help now,” Pimco’s Gross said in an Oct. 11 post on Twitter. “He who hesitates is lost.”
Looming over the decision is the year-end reckoning of Rajoy’s first year of austerity. With tax receipts shrinking, the prime minister is betting that he can defy expectations and deliver on his commitment to a deficit of 6.3 percent of gross domestic product this year.
“He’s more likely to get a negative surprise than a positive one,” Garcia-Montalvo said. “I wouldn’t take this bet.”
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