The Spanish government's 2013 budget ticks the right boxes. It opens the way for a long-expected euro zone bailout. But the path ahead won't be smooth.
The budget announced on Sept. 27, coupled with a reform package, aims to show that Spain is doing everything it must and can to qualify for financial assistance, without additional conditions imposed by its would-be saviours at a later date. It includes a further €13-billion of spending cuts and tax increases, and a promise to accelerate reforms over the next six months. Olli Rehn, European Economic Affairs Commissioner, even made the trip to bless the package.
The budget is based on optimistic economic assumptions. The economic contraction next year is likely to be worse than forecast. Barclays Capital expects a GDP contraction of 1.8 per cent in 2013, versus the government's 0.5 per cent forecast. Tensions with autonomous regions, particularly Catalonia, will make it hard for the central government to enforce austerity, and could even spark a full-blown political crisis. Markets might normally recoil at such a bleak economic outlook, but the prospect of ECB bond buying has dulled their wits.
With 10-year bond yields remaining at an uncomfortable 6 per cent, Spain has little to gain from delaying a bailout. Prime Minister Mariano Rajoy may stall until regional elections in October, after which markets will force his hand.
The stage is being set for an historic political and economic experiment. Bailing out the euro zone's fourth-largest economy will strain the political unity of the zone and be the first test case of the bond-buying plan of Mario Draghi, the European Central Bank president. Recent comments from Germany's finance minister suggest Berlin is reluctant to approve a Spanish sovereign bailout coming so soon after the country's bank rescue. And the ECB isn't showing its hand on what yield it will set for Spanish borrowing costs.
For the experiment to work, markets need to believe that the ECB will buy aggressively, and continuously. That in turn relies on Spain implementing its plan in good faith. There is the potential for a virtuous circle, with lower sovereign yields bringing down the economy's costs of borrowing. But with high unemployment, relentless austerity and political strife, the road will be rocky.