The EU looked on favorably as Mariano Rajoy, just one day after a memorandum on the financial sector bailout, announced a 65-billion euro spending cutback. This is the last measure Spain will adopt in an attempt to meet its deficit objectives through 2014. The cutback is more intense that five previous cutbacks enacted since the crisis began in 2008, which altogether were more than 121-billion euros. For the very first time, Rajoy admitted that Spain's economy is in an "extremely serious situation." The country will stay in a recession next year. Growth will be just under zero percent.
At first the markets reacted positively, but without too excess enthusiasm. In this sense, it's important to track the performance of Spain's treasury bonds, risk premium and stock market performance over the next few days in order to see what might happen next week when the first bond issue to take place after the announcement of the cutbacks will take place. Some of the bond issues have already been approved by the Cabinet. The Prime Minister exhorted Spain to practice "responsibility, discipline and diligence," because the counry -- including the government, the private sector and households -- owes some 1.68 billion euros.
The government program targets four areas: cuting expenses, increasing tax revenues, improving how public administrations operate and enacting structural reforms that increase the flexibility of business activity. Combined, there are three measures: unemployment benefits are reduced to 50% of worker salary (now it's 60%), Christmas bonus payments are eliminated for government employees and the VAT will increase by 21%. The first two measures involve spending cuts of around 8 billion euros. The Ministry of Labor is thinking about cutting the payment amounts of unemployment benefits, which increases the incentives for workers to find jobs. But in the end, the decision will be influenced by how much the funding decreases. It is estimated that 73% of unemployed workers will be affected.
In regard to the VAT, experts fear what increasing it will do to the Spanish economy and the possibility that it could create a situation similar to the last debt issue: an initial increase to the amount of revenue taken in followed by a fall in revenue. Further, there is a fear that consumption will fall and the recession will deepen. Besides these three measures there are others that will prompt the reorganization tactics for local companies, such as nixing unuseful jobs, cutting town councellor posts by 30% or doing away with local public limited companies. Rajoy did not include regional governments in the measure, becuase by law he can't get involved with the decisions they make, but all indicators suggest that within the Fiscal Policy Council that is meeting today, the government, following the methodology used by the European Commission, will impose conditions for developing the aid package that regional governments will need in order to get financing.
The cutbacks that regional governments will enact will give a real sense of the severity of the mesuare and the effectiveness of public sector reform. All these decisions, with their major social and economic and budget impacts, ought to have been adopted months ago when Rajoy took office with a political leeway that no other Spanish government has bad before now. It was possible that he could maintain the EU and the markets' confidence in Spain. Now, it's important that he regains it.
