Spain: Reform, Grow, or Restructure?

Tens of thousands of protestors took to the streets of Spain’s capital on Sunday to protest against new austerity measures that will hit health and education benefits.

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Heavy rain kept the numbers hitting the streets down, but more protests are expected on Labor Day on Tuesday, May 1.

With borrowing costs rising for Spain, and Standard & Poor’s last week downgrading the euro zone’s fourth-biggest economy by two notches, pressure is growing on Madrid.

The Financial Times reports that the government of Prime Minister Mariano Rajoy is working on a so-called bad bank scheme that will see problem loans ring-fenced into one or more asset management companies in a bid to take pressure off the financial institutions, which lent billions of euros to homeowners who are now either in negative equity or unable to meet payments due to unemployment .

Rajoy said he would push on with reforms that he believes will help get some of the 5.64 million unemployed Spaniards back into work.

With unemployment at 24 percent and half of all young Spaniards out of work, it’s hoped that this will work, despite doubts increasingly being raised about the credibility of government austerity as a way to reduce debt.

Reform the Answer

Labor reforms will help, according to Unicredit Chief Economist Eric Nielson.

“Remember that the numbers of hours worked as a share of the labor force in Spain is not materially different from most other European countries, but the distribution of jobs is,” Nielson said, following Friday’s awful jobs data.

His view is that the Spanish economy needs more part-time jobs and believes Rajoy has implemented reforms that will help achieve job creation.

Analysts at Barclays Capital believe the jobless rate will continue to increase well into 2013, despite reforms.

“The Spanish labor market trend, to a large extent, is a reflection of the hangover from a boom-bust in the construction sector, which for many years has been an important source of employment growth,“ said Fabio Fois, a European economist at Barclays Capital.

Believing that structural labor reforms will play a role in boosting the number of Spanish unemployed, Fois believes that only growth will have a major impact reducing the number of people out of work.

Growth to the Rescue

Growth is at least now on the agenda for Europe, but how the euro zone achieves it remains far from clear.

The discussion risks driving a rift between Germany and its core-partners such France and Spain, and is unlikely to lead to a growth pact anytime soon.

“There are some good reasons to be cautious over the extent to which the policymakers’ apparent recognition of that will translate into any sort of improvement in the economic outlook,” said Jonathan Loynes, the chief European economist at Capital Economics, in a research note on Friday.

With economic data pointing to a fall-back into recession for much of Europe, Loynes questions the likelihood of growth coming to the rescue over the next year or two.

“Against this background, it is not surprising that euro-zone policymakers have started to worry more about growth,” said Loynes, who sees little backing from German Chancellor Angela Merkel or the European Central Bank for a comprehensive plan. “But it is also very clear that they face a huge challenge to generate the solid rates of economic expansion required to make the austerity programs in place across the region a success.”

He added: “Mario Draghi’s call for growth was no indication that the ECB is itself about to take much more aggressive steps – such as a move towards full-blown quantitative easing to support the economy.”

With no growth, and austerity the key policy response, Spanish borrowing costs continue to rise, dragging Italy with them, and ending the short respite from the European debt crisis that the ECB’s long-term refinancing operation program gave investors in the first quarter.

Learning From the Greek Experience

Labor reform, austerity measures, and talk about growth pacts will not change Spain’s fate, according to an economist who predicted Greek debt restructuring.

“The time to restructure Spain’s debt burden is now, before the market declines to fund its cash needs, and before billions are squandered ‘unfixing’ its finances,” said Carl Weinberg, the chief economist at High Frequency Economics, on Monday.

“Any other course of action will not avert an eventual restructuring and will place potentially unaffordable burdens on EU public finances,” said Weinberg, who believes the sheer amount of Spanish government debt due to be rolled over in the next few years is the major problem.

“If that debt burden could be spread out smoothly over a longer period of time, the mountain of maturities over the next six years would become affordable,” said Weinberg, who says there is no time to hesitate. Otherwise…well, Greece’s disaster tells what to expect.”