Madrid: Spain’s new government will unleash a wave of spending cuts and strengthen economic reforms in the first months of its legislature, moves that will throw the economy back into recession and send unemployment higher before making things better.
Polls show the centre-right People’s Party storming to an absolute majority in the parliamentary election on 20 Nov, sweeping aside the seven-year-old Socialist government blamed for a deepening crisis and high unemployment.
Mariano Rajoy (C), leader of Spain’s centre-right opposition People’s Party (Partido Popular), is greeted by supporters after the end of his electoral campaign rally in the town of Inca (File photo Reuters)
The task facing the PP will be to assure markets that Spain will continue to do everything to meet its pledges to shrink the deficit, while stimulating a stagnant and worsening economy being hit hard by the European debt crisis.
While cutting the deficit remains a key target, at home both parties focus on reducing unemployment as the main aim.
But a much deeper reform of the labour market, which the PP plans, and even tougher cuts needed to meet deficit targets in the year ahead, will help push the economy into recession, and send the 21.5% unemployment rate higher in the short-term.
“The first half of the year will be hard because they will have to cut brutally. It will be the hardest we’ve seen in the crisis,” said Pablo Vazquez, director of economic think-tank FEDEA.
He believes the PP must take radical moves to make Spain more competitive . Rigid labour laws, expensive severance pay to lay off workers, high regulatory compliance costs and salaries tied to inflation all make Spanish companies less competitive.
“It will be a painful process, but if it’s done well Spain will come out of it stronger and it well help the euro zone.”
Exacerbating the downturn
He said a short-lived recession was possible over the coming quarters, in line with other euro zone countries, although Spain’s economy will be hit further by new cuts and reforms.
Even PP think-tank FAES recognized that Spain’s economy will not see decent growth until after 2012 and 2013.
PP leader Mariano Rajoy has warned he will “take the scissors to everything except public pensions, health and education.”
Top on the agenda he said would be a restructuring of government administrations, including the possible closure of public foundations and works, with a freeze on hiring too.
The economy stagnated in the third quarter and many analysts now forecast a contraction by year’s end as a global downturn bites into exports that had supported a feeble recovery.
In 2008 Spain’s economy fell into a recession that was fiercer than that in other European countries thanks to the bursting of a housing and construction boom. Unemployment soared from 8.6% at the end of 2007 to more than 21% currently.
For a decade previously Spaniards had piled into a booming housing sector in a binge fueled on cheap bank credit at a time when low euro zone interest rates stimulated prices in southern European countries.
Banks also gobbled up large swathes of property then got dumped with even more when the crisis forced land developers and Spanish families to hand over the keys when they could not keep up with payments.
The PP has said it will intensify a restructuring of the banking sector to assure markets have confidence in the country’s banks, and capital flows again to businesses.
The Socialist government and the country’s 17 autonomous regions got carried away with a spending spree too, pushing up the public deficit to 11.2% of economic output in 2009.
Hefty cuts, more reform to come
With analysts predicting some slippage of the government’s public deficit target this year of 6% of gross domestic product, even steeper cuts next year are inevitable if an optimistic target of 4.4% in 2012.
The Socialists constructed the target on a forecast for the economy to expand by 2.3% next year, but now analysts see the economy growing by only half that much.
While Rajoy has ruled out cuts to education and the health system, other PP leaders have made cuts in those areas in autonomous regions they control, sparking protests.
“The new government will need to explain clearly that the measures they take will not solve things in the short-term, but they would help the economy recover in the medium term,” said Miguel Cardoso, chief economist for BBVA Research.
Rajoy’s economic team believes cuts will generate market confidence and bring down government borrowing costs, which have shot up close to unsustainable levels. That in turn will open up credit between banks and businesses, and in turn spur economic growth.
Cardoso said reforms should be carried out to help stimulate business growth, reducing the costs of opening a business.
Indeed, the PP has said it will cut business tax by 5% points and encourage profits to be reinvested in to modernizing businesses. A PP win is viewed largely positively by business groups and the small to mid-size companies that form the backbone of the economy.
“A likely PP win, given the party’s past in helping business gives us a slight hope of a change in the economic cycle. But job losses, with close to five million out of work, will hit family spending even harder and make it difficult for small companies to find profitable areas to grow”, said Inigo Ibanez, head of Censor, a small consulting business in Madrid.
Labour unions are sceptical that cuts are the answer, and say European capital Brussels is dictating policy for Spain.
“From what the PP has announced they will do so far it is nothing more than the continuation of policies that are leading Europe towards disaster,” said Javier Doz of Spain’s largest union federation CCOO.
He said a radical change would need to be seen to stimulate growth, but wants the PP to force businesses to commit to hiring in exchange for wage moderation and a weakening in union power to negotiate wages.