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The perfect storm

16 November 2011 By Fiona Maharg-Bravo, Neil Unmack

Spain’s next government was never going to have much time to ease into the job. But the recent steep rise in borrowing costs – triggered by problems in Greece and Italy – will make life even tougher for Mariano Rajoy, whose opposition Popular Party is tipped by polls to win the elections on Nov. 20 by a wide margin.

One of Spain’s strong points is that its debt to GDP will end the year at 68 percent, lower than the European Union average and far below Italy’s 120 percent. The snag is that spiraling debt costs could eventually make the debts unsustainable. At current seven-year rates of 6 percent, Spain would need to run a primary fiscal balance of 1.8 percent just to keep its debt/GDP ratio stable in the long run, according to Breakingviews’ latest calculator. That’s well above the primary deficit of 3.5 percent that the European Commission predicts next year for Spain.

This scenario assumes Spain refinances all its debt at current rates – whereas its average debt to maturity is 6.6 years and the average cost of servicing it is just 3.98 percent. That means Rajoy doesn’t have to move into primary surplus in one swoop. But given that the government will probably miss its 6 percent budget deficit target this year thanks to profligate regions, the incoming PM will need to regain confidence quickly. Otherwise, Madrid – which needs to roll over more than 110 billion euros of bonds next year – could get sucked into a debt spiral.

Rajoy faces a tricky balancing act of cutting the primary deficit without hurting growth too much. That’s why he must also rapidly reform labour and services markets while creating more incentives for companies to create jobs. Any euphoria from the elections will be short-lived.

Breakingviews calculator: Spanish storm


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