08 March 2012

WSJ: Spain tests Europe's resolve on deficits

Spanish Prime Minister, Mariano Rajoy, formally opened the issue last week when he announced that Spain's new budget-deficit target would not be the 4.4 per cent that his predecessor agreed last year with the European Commission in Brussels, but 5.8 per cent.

The reason: Last year's deficit turned out to be 8.5 per cent, not the 6 per cent target that this year's goal was based on. Hitting the agreed 2012 target would cut domestic demand by four percentage points, further squeezing Spain's already shrinking economy.

It wasn't only Mr Rajoy's unilateral decision that upset the Brussels bureaucracy. It was the way he framed it, telling reporters: "This is a sovereign decision made by Spain that I am announcing now, to you".

Given that he had a short time before signed a new fiscal compact with 24 other European Union governments—the latest of a series of accords that explicitly cede budget sovereignty to Brussels—this undermined the very point of two years of German-inspired efforts to tighten eurozone budgetary discipline.

For Germany and the European Central Bank, these budget agreements are central to the future of the eurozone. ECB president, Mario Draghi, described them Thursday as "pillars of trust" between countries.

"If Spain is given the leeway it seeks, it will effectively be driving a coach and horses through the eurozone's new German-inspired fiscal regime", says Nicholas Spiro of Spiro Sovereign Strategy in London.

In a possible signal that Mr Rajoy should tread carefully, Spanish government bond yields have risen slightly over the last week, according to data from Tullett Prebon. Yields on Spanish 10-year bonds are now noticeably higher than Italy's: before Mr Rajoy spoke they were lower.

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