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Setting limits

13 January 2012 By Fiona Maharg-Bravo, Neil Unmack

Spanish regions are like teenagers pushing their parents to the limit. The country’s 17 autonomous regions, which are responsible for education and health (over 50 percent of total government spending), missed their fiscal targets again last year, and caused the country to miss its own. Madrid faces the same dilemma as the European Commission when it comes to ensuring compliance of member countries with the stability pact: how to force the regions to follow the rules?

The government’s sticks so far haven’t been too effective. It has prevented some regions from issuing long-term debt and demanded rebalancing plans from overspending regions. But instead of cutting back, the regional governments have delayed billions of euros in payments to suppliers and issued expensive, one-year bonds geared to retail investors. To be fair, some regions like Catalonia and Castilla La Mancha have started to cut back in earnest after a change in the local government. The real problem is the lack of efficient sanctions to stop overspending, just as the euro zone found with sovereigns in southern Europe economies. The regions’ financial autonomy is enshrined in the Constitution. But the current system doesn’t look sustainable. The region of Valencia came close to defaulting on a bond earlier this month. The government reportedly stepped in, though it was later denied.

One option would be to let one of the regions default to set an example, with the central government taking over its finances. This is basically what happened with Greece and the euro zone. But it could drive up the more responsible regions’ funding costs. Moreover, debt relief would be modest, as region’s don’t have that much debt to haircut at the moment. Total regional debt is 135 billion euros, or about 13.5 percent of the country’s GDP (not including about 30 billion euros in accounts payable to suppliers). The problem is that it is rising fast.

As part of the framework agreed with the previous government, the regions must halve their deficits from an estimated 2.7 percent of GDP last year to 1.3 percent. Most of them are governed by the ruling conservative party, so it should be possible to beat them into submission. But Madrid should not take any chances. This year, the regions need to roll over 17 billion euros of debt, according to Moody’s. The government is preparing a new law that will set annual spending caps for the regions and establish penalties for breaching them. The government should demand tough concessions if it ever has to step in. Repeat fiscal offenders should be forced to submit to a central authority that can temporarily oversee budgets and control spending. Such a surrender of independence would be controversial but after all, this is the threat that hangs over the central government too.


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