After Luis de Guindos said that a continued recession in Spain would cause the economy to contract by nearly 1.5% in 2013, the risk premium dropped yesterday for the first time in months. The spread between the German bund, a figure that tracks investor confidence in the Spanish economy, closed at around 300 basis points, about 25 points less than yesterday.
The drop marks a downward trend and practically assures that the EU will give Spain two more years to get its deficit-to-GDP ratio down to 3%. Now that the economic situation is different than before, European stock markets are posting significant gains (the Ibex closed at 3.27%), indicating that the European sovereign debt crisis may be over. What happened to cause this 180-degree flip? This long crisis has shown us that premature optimism only causes more misunderstanding of what is going on with the overall economy. That said, some important events have taken place.
The president of the European Commission, José Manuel Durao Barrosa, announced that the EU?s reticence to do take action during the crisis has come to an end. The markets took these words to mean that peripheral economies would receive fianncial aid from the EU and would be able to reduce their deficits. The EU seems to have bent under pressure from the IMF, which warned the euro zone of the need to increase its economic growth soon. For the same reason, it is believed that Mario Draghi is not going to wait much longer to lower interest rates, and that also explains why markets rebounded. Given these positive signs, the question now is whether there are sufficient reasons to believe -- as Finance Minister Cristóbal Montoro said -- that the risk premium falling is "the prelude to recovery." Figures from the Bank of Spain from Q3 2013 and Spain's Encuesta de Población Activa (a survey of the active working population that gauges key employment metrics, it will be published later this week) tell the real story of Spain's economy: it will take a long time to restore its health, and the work will be hard.
Unemployment and weak domestic consumption in Spain and other European countries will be the toughest road blocks to recovery. Spanish exports, the only raft holding our economy up, stalled in the first quarter of this year on low sales figures. The government rightly said that the recession will stick around this year. GDP has dropped 2% year to year. The biggest struggle now is how to fix a big structural deficit that is plaguing regional and national governments. It was one percentage point higher than estimated. Tax revenues will fall by 3.5 billion euros, which means that further cutbacks will ensue as the risk premium continues to fall and stabilizes around 200 or 250 basis points. This cheaper financing would allow us to save 6.8 billion euros in financing cost and balance out the loss of tax revenues.
Rajoy should take advantage of the lower risk premium and the EU's decision to give Spain more time to meet its deficit goal to finish carrying out pending reforms. The European Commission is going to examine with a fine tooth comb the decisions that the Council of Ministers will make on Friday. Spanish citizens will not accept any word games. The government should honor the sacrifices that people have made the past few years and finish the work it started in order to create a better economic model to paves the way for a recovery.