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Tricky maths

5 January 2012 By Fiona Maharg-Bravo

Spain’s new government can’t afford to ease into the New Year. It has inherited a deficit of more than 8 percent of GDP in 2011 and wants to stick to the target of bringing it down to 4.4 percent this year just as the economy is slowing down. The maths looks difficult, if not impossible.

To reach this year’s target, the government needs to find savings worth 3.8 percent of GDP, or about 38 billion euros. But that doesn’t factor in the increasing risk of a recession this year. The government last week announced spending cuts of 8.9 billion euros as well as 6.3 billion euros worth of tax hikes. These will hit growth, already much lower than anticipated. The original 2012 target was agreed by the previous government under the assumption that Spain’s economy would grow by 2.3 percent this year. Instead, it could shrink by up to 1.5 percent, according to Goldman Sachs estimates. The bank’s economists reckon the deterioration could fully offset the measures announced last week and send Madrid back to square one: having to find another 38 billion euros in savings.

The government says it can find another 8.2 billion euros with a new plan to combat fraud, a wide-spread phenomenon. This would certainly help, but even if it meets this optimistic target the government will still have a huge mountain to climb.

At least taking strong measures early on is sending a signal that Spain is committed to doing what it takes to hit its targets. So eventually missing them may not matter too much, as long as the country’s finances are headed in the right direction. The new economy minister also said that from now on, Spain’s regions will have to get the green light from the central government for their individual budgets.

More important is that Spain can show it will eventually grow again. That’s why the government is also focused on structural reforms, which are crucial to get Spain’s 23 percent unemployment rate down.

The government hopes this will be enough to generate confidence, its favourite catchword. And that will create the right conditions for growth. For now markets remain wary. Spanish yields have edged higher since the beginning of the year, showing there isn’t any room for complacency.

 

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