Photographer: Pau Barrena/Bloomberg

What to Watch as Spain’s Socialists Make Bid to Form Government

Discussions can continue for months even if pact parties lose.

The leader of Spain’s Socialist party, Pedro Sanchez, faces a confidence vote in parliament this week, after signing a pact with the pro-market Ciudadanos to try to form a government.

But with too few seats between them, they are likely to lose this week’s votes, analysts say, setting the clock running on a two-month deadline before new elections must be called. Losing both votes in parliament this week doesn’t make new elections inevitable, although the current political impasse means that’s still the most likely scenario for many commentators.

Who’s who?

Socialist party (PSOE), which ranked second with 90 seats in Spain’s December election, is seeking to form a government. It declined an offer to enter exclusive talks from left-wing Podemos, which it narrowly beat at the ballot box.

Instead, it has signed a pact with Albert Rivera’s Ciudadanos (Citizens) party, which came fourth in the general election with 40 seats. The pair would need either left-wing Podemos or the incumbent People’s Party to abstain in order to take office. Sanchez told his party’s leadership he would approach other Spanish parties to back his plans.

albert

Albert Rivera, the leader of Ciudadanos, in Madrid. 

Photographer: Mariano Herrera/Bloomberg Markets

Partido Popular (PP) came first in the election, but its share of seats fell to 123 from 186. Leader and acting Prime Minister Mariano Rajoy has said he’ll seek support to form a government if PSOE’s plan fails, while acknowledging some opposition within his own party. Rajoy turned down the King’s invitation to face a confidence vote, saying he didn’t have the support.

Anti-austerity group Podemos overcame a mid-year slump to claim 69 seats, challenging the Socialists’ traditional monopoly over progressive voters. Its support has ebbed in recent opinion polls.

What’s the latest?

Socialist leader Pedro Sanchez signed a pact with the liberal party Ciudadanos that could form the basis of a governing coalition. The two parties don’t have enough lawmakers on their own to win this week’s confidence vote, as 176 seats are needed for a majority compared with 130 the two parties currently hold.

PP won’t back the pact reached by the Socialists and Ciudadanos due to policy-based disagreements, Acting Deputy Prime Minister Soraya Saenz de Santamaria says.

Rajoy told EU leaders he expects new elections and says he will seek to form a government if Sanchez fails to win the vote.

What’s next?

The parliament plenary starts today. The first confidence vote is due on March 2, with Mundo reporting a second vote may take place on March 4. To win the first vote, PSOE/Ciudadanos need a majority while they only need a plurality in the second vote. If PSOE fails to form a government, all parties have until the start of May before new elections are triggered.

If the PP party were to abstain at the second vote, PSOE and Ciudadanos could form a government with a slim plurality, but it may not last long, Roubini analyst Michelle Tejada says. A grand coalition might be possible were Rajoy to step down (or aside) to clear the path, but may still not be enough given policy differences, she says.

Spanish Socialist Party leader Pedro Sanchez greets supporters before a press conference after the partial results of Spain's general election in Madrid on Dec. 20, 2015.

Spanish Socialist Party leader Pedro Sanchez greets supporters in Madrid on Dec. 20, 2015.

Photographer: Javier Soriano/AFP via Getty Images

The likelihood of new elections has increased, given Podemos and PP said they will vote against PSOE’s plans, Societe Generale analysts write in client note. Opinion polls suggest any new parliament is unlikely to secure radically different numbers, so the imbroglio may not be resolved even after a fresh vote, the analysts add.

A deal between PSOE/Ciudadanos and Podemos seems very unlikely as it would entail a massive u-turn, Teneo analyst Antonio Barroso says in e-mailed comments. The question is whether anything would change after two failed votes. Podemos’s support falling in the polls may make them more amenable to a deal, although that would also entail a significant political cost, Barroso adds.

PSOE’s program is still quite left-leaning and seems designed to put pressure on Podemos to back them, Eurasia analyst Federico Santi says in an interview. Significant differences between the two remain on economic policy, but especially on the issue of Catalonia, he says. Pressure may build on all parties to come up with a solution as an early-May deadline nears to form a government or face new elections, Santi adds.

What does it mean for markets?

Investors took out 70 billion euros ($76 billion) in 2015, after bringing funds into the country for two years in a row, the Bank of Spain said Monday. That’s the biggest outflow since 2012.

The pact between the Socialists and Ciudadanos is credit-negative, and bonds look to be in no-man’s land for months to come, Societe Generale analysts said in a client report last week.

Commerzbank analysts expect the yield spread between Spanish and Italian government bonds to remain range-bound, as political risks in Spain offset banking concerns in Italy.

Spain 10-year yield spreads over bunds may widen to the 150-basis-point area as the confidence vote at the end of the week approaches, Gianluca Ziglio, a strategist at Sunrise Brokers LLP in London, says in an interview. Sharper moves are unlikely in the near term given a policy decision expected from the ECB this month. That could change though if new elections in Spain are called, Ziglio adds.

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