The critical test for economic recovery plans of the euro area was never Greece but Spain and the European Union shows signs of failure, according to a Bloomberg analysis. The new Spanish government’s austerity plan failed to win investor confidence, which is a danger not only for Spain but for the whole Union, and European governments must change their strategy before it is too late.
Spain’s bond auction on Wednesday was the first verdict for Spain’s budget and is not favorable. Demand was weak, price fell and yields for securities with maturity of 10 years reached 5.7%, its highest level this year. The problem is that the austerity plan is too hesitant. Instead, at the EU command, Spain promises the most drastic fiscal consolidation program that faced any European country. The new plan aims at reducing the budget deficit from 8.5% of GDP last year to 5.3% in 2012. With the economy already in decline, spending cuts equivalent to 4% of GDP are required, while unemployment rate is already at 23%. Spain has exceeded last year’s budget deficit target for the regional authorities have not met their target, while economic growth was below expectations.
The situation is likely to happen again because excessive austerity hinders economic growth, leading to new loans, despite government efforts. Thus, as the government manages to reduce public spending, the outlook is less favorable for growth and public debt. Unemployment rate is 23%, but reaches 50% among young people and government efforts to reform the labor market can hardly be supported by population during a recession. Greece’s economy is small, but the Spanish economy is the fourth largest in the euro area. If Spain will collapse, it will draw with it the protection mechanisms, still fragile, of the EU.
Operations of the European Central Bank (ECB) to add liquidity, which banks lent more than 1,000 billion euros, helped stabilize financial markets, but the worsening problems of Spain show that calm only was apparent. Spain can not overcome the crisis without the support of its European partners, who, in their own interest, should allow a moderate fiscal consolidation and support economic growth of the country. This requires the support of economic growth across the EU, including a relaxed fiscal policy in Germany and a supportive monetary policy from ECB.
One measure would be for the ECB to announce that it will act as lender of last resort for governments with financial problems in the euro area reads the article. Spain is drawn into a vicious circle of economic, fiscal and political collapse. The danger can be avoided now, as long as the EU is willing to act. But if it waits too long and Spain will fall into the trap, damage control will make the support of Greece seem like child’s play.
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