Bracing for Bailouts Which EU Problem Child Will Be Next?
Part 4: Spain - Litmus test for Europe's Rescue System
At first glance, Spain's financial situation is deceptive. Its public debt looks rather small compared to other EU countries, at just 53 percent of gross domestic product. According to the Maastricht Treaty, government debt is allowed to be up to 60 percent of GDP. Countries such as Ireland and Germany have significantly higher debt levels, at 65 percent and 75 percent of GDP respectively.
Nevertheless, Spain is in the middle of a serious crisis. The reason is the high level of unemployment, and the massive collapse in property values.
The financial crisis brought an abrupt end to a construction boom that had lasted for years and which had been largely financed by loans. Hundreds of thousands of Spaniards lost their homes, while 1.2 million found themselves out of work. Bad loans totaling 180 billion still place a burden on the country's financial institutions today, with half the loans being held by the savings banks, the cajas. The country plunged into a deep recession.
Since the spring, the government has been trying to forcefully fight the crisis, partially as the result of pressure from the European Union and the International Monetary Fund. Prime Minister José Luis Rodríguez Zapatero introduced an austerity package that goes beyond what any other country has done so far. He pushed for major reforms in the labor market, including the easing of job protections and a reduction in high severance payments.
In the next three years, the government wants to save a total of 50 billion through drastic cuts. An additional 15 billion will be slashed from the budget this year and next. To help achieve this end, the government is cutting civil servants' salaries and slashing subsidies. The goal is to reduce the budget deficit from the current 11.2 percent of GDP to under 3 percent by 2013.
An Entire Generation Dependent on Their Parents
At the same time the government is trying to increase its revenues. Back in the summer, it raised the rate of value-added tax (VAT) from 16 to 18 percent. But the Spanish reacted by immediately reducing their consumption, thereby delaying the economic recovery that was expected to follow the financial crisis even further. After a meager annualized growth rate of 0.2 percent in the second quarter of 2010, the economy stagnated completely in the third quarter.
But the Labor Ministry assumes that new jobs will only be created if growth hits at least 2 percent. And those jobs are urgently needed: The unemployment rate in Spain is at 20 percent, while among young people it is twice as high, at 40 percent. A whole generation is dependent on the support of their parents. They struggle to find jobs and get temporary contracts at best.
The next acid test will happen soon: Next year, Spain must raise 65 billion on the capital markets in order to refinance its debt. And that could turn out to be expensive. For example, on Wednesday, interest rates on Spanish 10-year government bonds rose to over 5 percent for the first time since 2002.
There is a lot at stake -- including for Germany. That is partly because German banks have lent about 134 billion to Spanish banks and companies. Another reason is the fact that the EU's 750 billion rescue fund was not designed to cope with the possible default of a large country like Spain. In other words: If Spain falls, so does the euro.
- Part 1: Which EU Problem Child Will Be Next?
- Part 2: Ireland - The Export Industry as the Trump Card
- Part 3: Portugal - The Next up for a Bailout?
- Part 4: Spain - Litmus test for Europe's Rescue System
- Part 5: Italy - The Curse of the Relics
- Part 6: Greece - Reform with Risks