Sniffles in Spain Euro-Zone Contagion Has Madrid Deeply Worried

The Spanish have less debt than the Germans, and they've set strong austerity measures in gear. Nevertheless, they might become the next victims of the euro crisis. Madrid's troubles show that individual nations can hardly defend themselves against speculative attacks.

Wrong direction.

Wrong direction.

By Suana Meckeler and

Horror has a name: the zona de rescate, or rescue zone. That's what the Spanish media calls the region above 7 percent on international bond markets. When Greece, Portugal and Ireland had to start paying 7 percent, they were forced to seek help from the European Union in carrying their national debts.

On Thursday, Spain lurched a hair's breadth away from the zona de rescate. In an auction of 10-year government bonds, the nation had to offer investors interest rates of 6.975 percent. It's the highest rate Spain has paid since 1997, before the launch of the euro, and the shock came only three days before a parliamentary election that will probably topple the government of Socialist President José Luis Rodríguez Zapatero.

"We need a European Central Bank (ECB) that can earn its title and defend the common currency and its countries," Zapatero said Thursday.

It has become an increasingly common plea. Many would like to see the ECB invest massively in European bonds and bring interest rates for borrowing among stricken EU nations down to tolerable levels. French and Italian politicians have demanded similar intervention. Germany, though, remains opposed and has blocked the so-called "bazooka" strategy so far. Both Germany's central bank and Angela Merkel's government have warned that ECB intervention would introduce the threat of higher inflation and reduce pressure on debt-laden countries to balance their budgets.

Not Just Another Victim

Spain has slipped into grave economic trouble: The country is still struggling with the results of a burst real-estate bubble as well as elevated private debt levels. Unemployment has risen faster than in any other industrial nation. Roughly 20 percent of the working-age population is out of a job, an EU record. The economy is recovering sluggishly. The government just lowered its growth projections for the coming year from 1.3 to 0.8 percent.

Still, Spain is not just another victim of the euro crisis. The country's relatively strict banking regulations allowed it to survive the international financial crisis with only light damage. And in the current debt crisis, the Spanish have been model students: With a national debt at some 61 percent of gross domestic product, Spain lies far below Greece (145 percent) and Italy (118 percent) -- but also comfortably below Germany (83 percent).

"Even panic-mongers can't find terrible stories to tell about Spain," says Nicolaus Heinen, an analyst at Deutsche Bank. "The level of national debt isn't critical and important reforms have been put in place." But none of that seems to have helped. "The markets are now punishing any country vulnerable to even a whiff of doubt about contagion," Heinen said.

'Unambiguously Solvent'

Luis Garicano, a Spanish economist at the London School of Economics, finds the market speculation against Italy as well as Spain "outrageous." He says, "Both countries are unambiguously solvent. But this kind of market panic can be ruinous."

The example of Spain, in fact, shows that euro-zone nations can hardly defend themselves against speculative attacks. The government of Luis Rodriguez Zapatero has instituted perhaps overdue but truly ambitious reforms in response to the crisis. His government included a brake on government debt modelled on Germany's and instituted it in record time. "On Sunday no one had heard about it," Garicano says, "and on Friday it was law." The conservative People's Party, who will probably win power this weekend, have staked ground as the party of further austerity and reform.

Heinen, the Deutsche Bank analyst, thinks the situation in Spain will improve in the near future. "The growth prospects for next year don't look rosy, but in the mid-term Spain will improve."

There are a few hopeful signs. Spanish exports have recovered almost as rapidly as Germany's, which has helped to significantly slash Madrid's trade deficit. During the crisis, some companies managed to improve their productivity (which was long a weak point in the Spanish economy) and strengthened their net worth.

The Indignant and the Unemployed

The most serious problem is still unemployment, particularly among the young. No fewer than 46 percent of Spaniards under 25 lack jobs. "The job market is in serious trouble," says Garicano, though this isn't exactly news ."We've been living with high unemployment for many years. That's sad, but our social cohesion is still strong." Family structures are intact, in other words, and they can absorb the jobless.

Garicano compares the current recession to the one in 1976: The latest downswing drained the economy of about 10 percent of its jobs. Thirty years ago it was 14 percent, and the recovery took 13 years. Spain has survived worse. "We're a very resilient society," says Garicano.

But young Spaniards are at their wits' end -- as this year's protests by the so-called " indignados" in Madrid have shown. Spanish unemployment is not only due to the crisis, though: During the real-estate boom, many young people quit school because jobs in construction were so attractive. Now those jobs are gone.

Outgoing Prime Minister Zapatero reacted to the high unemployment by relaxing Spain's relatively strong protection measures against layoffs. The idea was to encourage companies to hire young Spaniards without resorting to disadvantageous fixed-term contracts.

Reducing the country's budget deficit likewise remains a challenge, as does preventing the collapse of a banking sector still reeling from the real estate crisis. The country's budget deficit remains high, at 9 percent of GDP -- will more than the 3 percent allowed by EU rules. Spain's largely autonomous regions, which retain significant control ovver their own budgets, remain an Achilles heel and are responsible for more than half of the budget deficit. But conservative politicians have been winning back power in the region and seem open to increased austerity.

Garicano says that the Spanish population is also largely unopposed to further reform. Spain recently raised the retirement age to 67, he points out, and the protests were minimal. He hopes that, once conservative leader Mariano Rajoy gets elected, markets will give Spain a breather.

Given the degree to which sovereign bond interest rates have shot up in recent days, however, that is no longer a foregone conclusion. Indeed, Zapatero's plea on Thursday for ECB help sounded more desparate than measured.

Controversial as the notion may be in Berlin, Garicano, for his part, sees no other choice. By joining the euro, he says, Spain "has become a sort of Third-World nation, because we borrow money in a currency which we no longer control." Now, he says, it is up to the ECB and Germany's central bank to demonstrate that they will not tolerate a Spanish insolvency.

"We will do our part," he says. "They have to do theirs."


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