Spain: Budget Woes Hit Regional Governments

Tourists strolling Las Ramblas or gawking at Antoni Gaudi's fanciful cathedral may not notice anything amiss. But beneath the streets of Barcelona, work on an $8.4 billion expansion of the city's subway system has slowed since Catalonia's regional government cut spending on the project by a third this year.

Even as Spain imposes austerity measures to slash its deficit, a fiscal crisis is brewing in the country's 17 regions, which spend almost double what the national government does. After lavishing funds on everything from theme parks to orchestras during a decade-long boom, Spain's local and regional governments have nearly $200 billion in debt. "We have to cut our budget by almost 13 percent next year," says Rosa Rodriguez, deputy finance minister for the Canary Islands. "It's very difficult."

Regional governments have agreed to a 5 percent reduction in salaries and a promise to replace only 10 percent of retiring employees. Yet "they may have to cut deeper," says Standard & Poor's (MHP) analyst Myriam Fernandez de Heredia. With Spain's economy forecast to shrink 0.3 percent this year, she warns that tax revenues may fall short of projections.

Spain's regional and local governments are turning to the debt markets to raise some $57 billion this year, far more than their counterparts in any European country except Germany. While German states can borrow cheaply, thanks to their top-notch credit ratings, at least 12 of Spain's regions have suffered recent downgrades. Investors now demand 3.3 percent for Catalonia's 12-month debt, more than a full percentage point higher than what they'll accept for Spain's sovereign bills. That's about triple the difference in 2007.

More than most European countries, Spain has ceded power to regional governments. They finance most education and health care as well as other social initiatives. Spending on such programs has increased even as regional tax revenues have shriveled by almost 9 percent over the past two years. During the boom, regions spent lavishly on projects such as Terra Mitica, a theme park in the Valencia region that features replicas of the Minotaur's labyrinth and an Egyptian pyramid. The park, 22 percent owned by the regional government, doesn't disclose its finances, but opposition politicians say it has lost $350 million since opening in 2000.

Adding to their budget woes, regions have created public companies and foundations to finance everything from stadiums to medical research. The number of such entities has grown to more than 2,000 from about 500 over the past decade. Andalusia, one of Spain's poorest regions, spends $3.9 million a year on a foundation to promote "peace, dialogue, and reconciliation through music," while Madrid's regional government has an agency that provides services to people from the capital who are living abroad. "There was an expansion of spending all around," says Angel de la Fuente, an economist at the National Research Council's Institute of Economic Analysis. "And they hired a lot of public servants that they cannot fire."

The bottom line: Spain's regions outspend the national government two to one, leaving many of them in dire fiscal straits as tax revenues shrivel.

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