Some calm may have been restored to Spanish bond markets, but it is unlikely to last. During the summer, the yield on Spanish ten-year government bonds soared to 7.5% as the market fretted about whether it could afford to pay them back. After being promised €100bn by its eurozone partners to sort out its crippled banking system, a sense of calm was restored – ten-year yields are now 5.6%.
But Spain’s problems are far from over. The Spanish government needs to cut spending. It has raised taxes to try to bring more income into its coffers, but the economy continues to shrink. Spain’s regions also control a lot of spending decisions and continue to overspend. Without a booming property market to provide lots of tax receipts, it is struggling to get anywhere near balancing the books. Increases in taxes, such as VAT, mean that cash-strapped households just spend less, compounding the problem.
The government now expects that the budget deficit (the amount by which spending exceeds income) will be over 7% of gross domestic product (GDP) this year. The International Monetary Fund (IMF) thinks that things won’t improve much in 2013 either. It predicts that the deficit will still be 5.7% of GDP and that total government debt will be over 90% of GDP.
With debt spiralling, it seems only a matter of time before Spain asks the European Central Bank (ECB) to bail it out. Prime Minister Mariano Rajoy doesn’t want to go down this road yet as it would mean losing control of Spain’s purse strings. But to get the government’s finances on a sound footing he’ll have to cut spending on state pensions, social security and government employees’ wages. With people already on the streets complaining about cuts, politics means that these tough decisions will continue to be put off.
So don’t be surprised to see Spanish bond yields rising again in the next few weeks. They’ll probably go down once the ECB starts buying Spanish bonds, but all that does is shift the problem elsewhere. Spain faces similar problems to Greece and Ireland. It can’t keep spending more than it takes in. Until it balances income and spending, its – and the eurozone’s – problems will not go away.