The Eurozone Crisis in Catalonia, with economist Edward Hugh: Part Three Featured
Third of a four-part series in which economist Edward Hugh explains the causes of the current Eurozone crisis and its potential implications for Catalonia.
In this interview series, Edward Hughes looks at the background to the Eurozone economic crisis and what its outcome might mean for people living in Catalonia.
Edward is a respected macro economist whose focus is on the effects of democratic changes on economies. He is regularly quoted in international publications such as the Financial Times and The Economist magazine. Edward has spoken to BcnIn before and contributes to a number of economics blogs as well as overseeing a lively Facebook community page which you can find here.
3.What can the incoming PP government do in the face of this situation?
Despite popular beliefs in Spain - where a great deal of importance and attention is focused on the political dimension of economic crises - the sad truth is very little. This reality is evident in the last statements of Jose Luis Rodriguez Zapatero (who called for the ECB to act vigorously) and Economy Minister Elena Salgado (who stated bluntly that the problem was a European and not a Spain-specific one) just before leaving office.
The new government will be caught on the horns of a dilemma, since the 2011 fiscal deficit is widely expected to come in at over 7% of GDP as opposed to the objective set in the Stability Programme of 6%. Mariano Rajoy can either try to dodge or accept the challenge that this situation presents. If he tries to dodge it - and according to one theory currently going the rounds the PP would like to postpone any deep cuts until after the Andalusian elections in the spring - then he will be dead on the starting block, despite being elected with the largest majority ever obtained by his party in the Spanish parliament. People who talk of trying to hold out until the spring are simply totally out of touch with the reality and the urgency of the present crisis.
On the other hand, if he accepts the challenge, he could wind up a victim of market sentiment just the same. Basically Spain's economy barely recovered from the previous recession and is now entering a second one. House prices have not ceased falling, and unemployment has been rising uninterruptedly since the end of 2007. This situation is putting enormous strain on the financial system, with all parties effectively agreed that the Spanish financial sector needs a second restructuring. The problem is there is no funding available for this at the Spanish level, hence eyes had been looking towards the European Stability Fund (EFSF) for support in this sense. But in the current environment the EFSF is also struggling to finance itself, and herein lies the problem.
The present situation is unsustainable, not only due to the high cost of funding Spanish debt, but due to the liquidity pressures that the falling value of Spanish government bonds is placing on the banking sector. The latter problem is much more important than the former in the short term, and indeed it was this pressure on bank liquidity (and not the sustainability of sovereign debt as such) that pushed first Ireland and then Portugal into a bailout. If we add to this problem that Spain's initial financial restructuring process is already leading to an acute credit squeeze which is basically strangling the real economy on the vine, then basically you have all the seeds of a truly full-blown crisis.
According to the latest EU Commission forecast, the Spanish deficit next year is expected to be 5.9% of GDP rather than the 4.2% objective set down in the EU stability programme. If Mariano Rajoy applies the kind of spending cuts which would be required to bring the deficit into line with targets in the context of an economic recession, then the probability is that Spain would have a rather severe economic contraction in 2012, similar to that which is currently occurring in Portugal. On this scenario the impact on unemployment would be severe (JP Morgan is already forecasting Spanish unemployment could rise to 27% in 2012), and the knock-on effect of this on non-performing loans in the banking sector correspondingly negative, and so on and so forth. So whichever way you look at it, Mr Rajoy is certainly facing a "heads I lose tails you win" situation, with no easy solution. Which is why I say at the outset that the response has to come at the European level.
The era of single country rescues has really come to an end with the arrival of Spain and Italy in the casualty unit. Both countries are of course, too big to save in the conventional sense, while at the same time if they both fail then the Euro in its present form is surely finished. In addition, the political dimension is much larger. Italy is not Greece, and Spain is not Ireland. It would be impossible to treat either country in the way which their smaller peers have been treated, and Europe's leaders are well aware of this.
So we are back to the backstop for the Euro, making large quantities of funding available to both sovereign debt issues and to the financial sector restructuring one, a restructuring which would almost certainly involve the costly creation of a bad property bank in order to take the large accumulated volume of toxic assets of balance sheets and free the system up for the provision of more normal credit. But as I said earlier, all we have from Europe's leaders at this point are vague promises coupled with silence on the key issues. A silence which becomes more and more deafening with each passing day. As ECB President Mario Draghi put it at the end of last week - highlighting the failure of governments to make operational the European Union's bail-out fund, the European Financial Stability Facility, launched 18 months ago: "Where is the implementation of these longstanding decisions?"
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