Spain may have a chance

Spain’s New Budget Focus on Spending Cuts

by PaterTenebrarum
For once, at least something positive has emerged from a new 'austerity' budget in the euro area. As Reuters reports, Spain's government has focused on cutting expenditure rather than raising taxes this time.

This is exactly how it should be done – it must be acknowledged that the economic pie isn't as big as it was once thought to be, due to the massive capital malinvestments of the boom. The attempt to leave the size of the government untouched while shrinking everything else and wringing more tax revenue from the contracting private economy is condemned to failure from the outset. The government's size must shrink in proportion, in fact the opportunity should be taken to shrink its size considerably further than that.

The method so far preferred by many euro area governments in their attempts to achieve the budget milestones of the 'fiscal pact' was to raise as many taxes as possible. We have discussed this in the past when criticizing Italy's Mario Monti and France's Francois Hollande with their focus on tax hikes, while they concurrently eschew or postpone genuine economic reform.

In this sense the new budget unveiled by Spain represents a certain degree of progress (with the exception of a big hike in VAT). However, as Reuters notes, from the announcement to the actual implementation, it is still a very long and rocky road: 

"Ministry budgets were slashed by 8.9 percent for next year and public sector wages frozen for a third year as Prime Minister Mariano Rajoy battles to trim one of the euro zone's biggest deficits."This is a crisis budget aimed at emerging from the crisis … In this budget there is a larger adjustment of spending than revenue," Deputy Prime Minister Soraya Saenz de Santamaria told a news conference after a marathon six-hour cabinet meeting. 

Beset by anti-austerity protests and threats of secession by the wealthy northwestern region of Catalonia, Rajoy is resisting market and diplomatic pressure to apply for a rescue, partly out of concern for national sovereignty but also because European Union paymaster Germany insists Spain doesn't need help. The central government sees budget savings of 13 billion euros in 2013, with spending down 7.3 percent — not including social security and interest payments — and income rising 4 percent thanks to a 15 percent leap in value-added tax take. 

The budget goes to parliament on Saturday and debates could last weeks. The country's 17 autonomous regions still must present budgets and find an additional 5 billion euros in adjustments to meet overall public deficit reduction goals. 

Spain, the euro zone's fourth largest economy, is now at the center of the euro debt crisis. Investors fear Madrid cannot control its finances and question whether Rajoy has the political will to take all the necessary but unpopular measures. 

Madrid is talking to EU authorities about the terms of a possible aid package that would trigger an European Central Bank bond-buying program and ease Spain's unsustainable funding costs. Brussels has demanded an independent budget oversight body, which Economy Minister Luis de Guindos said on Thursday would be created to review budget execution. The government is still analyzing potential conditions for aid, he said. 

The conservative government said tax revenue would be higher than originally budgeted in 2012 — partly due to a hike in VAT — allowing it to comfortably cut the public deficit to 6.3 percent from close to 9 percent last year. 

Uncertainty over Spain's ability to control spending in regional governments — which account for half of all public spending and could threaten the deficit goal — has increased due to the Catalan demands for independence.

The autonomous region's parliament voted on Thursday to hold a referendum on independence, but Saenz de Santamaria said the region must consult the rest of the country first.”(emphasis added)

Of course the government's budget projections rely on its own estimates of future economic growth, which are likely to be wide of the mark. These assumptions almost always turn out to be way over-optimistic.

Tapping Pensions

It was also reported that Spain's government would 'tap its pension fund' for €3 billion (in other words, it will do what Portugal, Ireland and Hungary have also done: grab pension money to fix a current liquidity emergency, well aware that the missing funds will be the problem of a future government).

What makes us wonder a bit is how exactly this particular three card Monte will be performed, since the pension fund has hitherto been used to prop up the government's debt auctions and therefore holds mainly Spanish treasury debt. As of March 2012 it held some €56.6 billion in Spanish government bonds plus €7.8 billion in other European sovereign debt.  As we already noted back in March, in conjunction with the banking system and the government bootstrapping each other, the whole thing is truly a Ponzi scheme writ large.