Spain's troubles worsen, sparking new phase for euro crisis

Spanish share prices plunged by more than three percent on Wednesday, as investors worried whether the European Central Bank and its partners have sufficient resources to rescue the ailing Spanish economy.

The nation’s bond yields rose sharply on Wednesday while equity markets across Asia and Europe also suffered selling as investors faced reality: Spain’s 2013 budget, to be unveiled on Thursday, won’t cut nearly enough spending to reach the 2012 deficit target of 6.3 percent of gross domestic product. 

 “There’s a good chance that whatever is announced tomorrow won’t be nearly enough,” said Ben May, an economist at Capital Economics.

Protestors took to the streets of Madrid on Tuesday night and looked set to stage new protests on Wednesday, underlining the public’s lack of appetite for further budget cuts.  That anger has spilled over to Spanish politics.  Catalan President Artur Mas on Tuesday called a snap election, asking voters to view the poll as a declaration of independence from Madrid, raising the real possibility of a full-blown Spanish constitutional crisis. Catalonia, in the north of Spain, and home to Barcelona, is the country's wealthiest region.

Spain is likely to request assistance from international creditors well before Catalonian voters go to the polls.  Analysts believe Madrid will accept defeat when 10-year bond yields top seven percent.  With 10-year yields creeping above six percent on Wednesday, a phone call to the ECB could be just weeks away.

But a Spanish rescue package won’t draw the euro crisis to a close.  Far from it, say analysts. Rather, a request for help from one of the euro zone’s larger countries would mark the beginning of a new phase in the region's debt woes.  For one thing, external assistance may be slow to reach the markets, as Spain is sure to resist some of the onerous conditions associated with programs designed to support the smaller euro zone countries. 

“Spain is unlikely to comply” with the conditionality demanded by lenders, said Nicholas Spiro of Spiro Sovereign Strategy. “It doesn’t see itself as a ward of the euro state.”

More importantly, those austerity conditions demanded by the troika of lenders – which groups the European Central Bank, the European Union and the International Monetary Fund – are exactly what is worsening recessions in a number of countries.   “Given the dire state of its economy, Spain needs further austerity like it needs a hole in the head,” said Spiros. 

Earlier on Wednesday, the Bank of Spain warned that the economy continued to contract “at a significant rate” in the third quarter.  The current recession – Spain’s second in three years – has left one quarter of the work force jobless.

“Spain is at a critical juncture,” said Spiro, as austerity has become “self-defeating.”  Further austerity only “depresses growth and eats into the tax base.”  That leads to sustained, or even increasing joblessness and a higher welfare bill.

The same could be said for other countries on the euro zone periphery – Greece, Portugal, and even Italy.  All face a raft of economic problems, namely a lack of competitiveness and a narrow tax base.  Exorbitant borrowing costs – the target of the Troika’s rescue mission – are simply “a symptom of deeper problems,” said May.

That’s why a Spanish bailout, whenever it comes, will buy some time for struggling euro zone nations, but will fail to address the region’s longer-term competitiveness problems.  “We know the record of time-buying strategies. They fail,” said Spiro. “Mr Draghi [ECB President Mario Draghi] is fully aware this is a short-term palliative at best.”

Only a full-scale banking and fiscal union, one that allows the mutualization of debts across the euro zone, will insulate soverign euro countries from sporadic attacks on fixed income markets.  “That may not come for years … or decades,” said Spiro.