Madrid threatens to intervene in regions

Spanish PM, Mariano Rajoy, has agreed with the EU to cut the deficit by more than 3 percentage points this year.

Story highlights

  • Spanish PM, Mariano Rajoy, has agreed with the EU to cut the deficit by 5.3 per cent of GDP
  • Officials said Madrid has threatened to seize budgetary control
  • Concerns about overspending by Spain's autonomous regions stripped bond confidence

Mariano Rajoy, prime minister, has agreed with the EU to cut the deficit by more than 3 percentage points this year to 5.3 per cent of GDP.

Madrid has threatened to seize budgetary control of wayward Spanish regions as early as May if they flout deficit limits, officials said -- as investors took fright at the fragility of some eurozone economies.

Concerns about overspending by Spain's 17 autonomous regions and fears that its banks will need to be recapitalised with emergency European Union funds undermined confidence in the country's sovereign bonds, forcing down prices and pushing yields up above 6 per cent on Monday -- towards levels considered unsustainable.

The cost of insuring the country's debt also rose, with Spanish credit default swaps jumping to a record 510 basis points, according to Markit, the data provider.

Mariano Rajoy, the Spanish prime minister who took office in December, tried to reassure investors, admitting that the country was only at the start of a long reform programme but insisting that the government would make the "gigantic effort" needed to restore the economy to health.

"Our commitment is to economic stability and reforms at all levels of the administration," Mr Rajoy said in Madrid at a meeting of family owned businesses.

One senior official vowed to intervene in errant regions "if things are not done, if there's no viability plan in place -- because they cannot finance themselves on their own".

Another said: "We are inclined to do it [take budgetary control] the same day we get data showing that an autonomous region won't fulfil its obligations."

Spain's total public sector deficit barely fell last year and amounted to some €90bn or 8.5 per cent of gross domestic product, far above the 6 per cent target agreed by the former Socialist government with the European Union. Most of the overshoot came from the regions, which manage schools and hospitals and account for just over half of all public spending.

Mr Rajoy has agreed with the EU to cut the deficit by more than three percentage points this year to 5.3 per cent of GDP. Of that the regions are collectively allowed to contribute only 1.5 per cent of GDP, which means they will have to halve their deficits from 2011.

Although Spain is one of the most decentralised nations in western Europe, Mr Rajoy's ministers said they have the legal power to force autonomous regions into line, not least because they cannot raise money to fund their deficits without central government permission.

One possible candidate for intervention is Andalucia in the south, Spain's most populous region, which has attacked Mr Rajoy's austerity measures. Mr Rajoy's Popular party had hoped to win a regional election last month and oust the leftwingers who have run Andalucia for 30 years but the PP did not get enough votes and the left remains in control.

Andalucia, however, is not alone in failing to obey fiscal rules. All the major political parties, including the PP, have exceeded deficit targets in the regions they administer.

Analysts and investors have become increasingly concerned over the health of the Spanish economy and its banking system, despite the introduction of tough austerity measures by Madrid and a €1tn cash injection by the European Central Bank into Europe's banking system.

Much of the money from the ECB's longer-term refinancing operation was used by Spanish and Italian banks to buy government bonds in the first quarter. But the effects of the LTRO appear to be wearing off, with analysts stressing that it merely bought time but was not a fix for underlying structural problems in the region's banks and economies.

Spain is due to auction short-term notes on Tuesday and sell a mixture of two and 10-year bonds on Thursday.

Renewed worries about Spain prompted Benoît Coeuré, an executive board member at the ECB, to say last week that the central bank should step up purchases of Spanish bonds, which have been on hold after the LTRO. However, other ECB board members disagree. The central bank said on Monday it had not bought any bonds for a fifth consecutive week.

"The fundamental economic problems surrounding Spain are not going away," said Alberto Gallo, head of European macro credit research at Royal Bank of Scotland. "We are wary of the pockets of insolvency risk. Spanish banks are one of them and will continue to be volatile."

Mr Gallo said the problem for Spanish banks was not one of capital, not liquidity. He said results from Banesto, which reported a sharp drop in earnings, highlighted the problem facing Spanish lenders.