Friday, September 28, 2012

More austerity in Spain brings it closer to formal request for assistance

Spain has announced a further round of austerity measures aimed at achieving its revised fiscal deficit targets of 4.5% of GDP in 2013 and 3.0% in 2014.  The measures are targeted mostly at cuts in spending although some tax increases are also part of the package.

As you would expect the government is forecasting its deficit targets to be achieved, but in our view they are based on GDP growth forecasts that will ultimately prove to be optimistic.  The Government is forecasting a GDP contraction of -0.5% in 2013 whereas the market consensus is closer to -1.5%.

The most meaningful announcement today was the establishment of an independent fiscal authority, much like America’s Congressional Budget Office (CBO).  Such an independent authority adds a significant element of internal robustness to the budget-setting process.  We like that. The Government also outlined a program of structural reform of the labour market and utilities sectors that will take place over the next few months.

More interesting than the new budget measures themselves is the implication for a formal request by the Spanish government for formal assistance via the EFSF/ESM and ultimately ECB assistance via the Outright Monetary Transactions process. 

There has been some recent criticism of the Spanish government that they have not already asked for formal assistance.  We think that criticism is unfounded.  Firstly, it makes sense to know what the rules are the game are before one participates.  The details of the OMT are still being developed.  Secondly, with a budget announcement just around the corner, it also makes sense to get that out of the way before ascertaining what other measures European officials might seek in terms of reform conditionality.  In that regard it must be reassuring to the Government that EU Commissioner Olli Rehn has endorsed today’s budget announcements as positive.

A further hurdle will be cleared tonight with the release of the independent audit of the Spanish banking system that will determine the capital requirements from the 100b that has already been made available.

It’s unlikely we will see an imminent request from the Spanish government for formal assistance.  It’s more likely that over the next few weeks the terms of any support will be agreed behind closed doors and then announced to the market in co-ordinated and tidy manner.  We'll see.