The risk of the deficit

The main goal of Spanish economic policy for 2011 may not be attained. The commitment of the Spanish government (both this one and the next) to the European Union was to reduce the public deficit to six percent of GDP ? one of the steps required to stabilize the shortfall at three percent. But the evolution of expenditure and public revenues up until September suggests that there has been a significant deviation from full compliance with the deficit target. This deviation cannot be blamed on falling revenues alone. It is obvious that the regional governments are not going to fulfill the objective of limiting their respective deficits to 1.3 percent (the most pessimistic estimates indicate that overall they may reach 2.3 percent), and also that the narrow margin of surplus expected for the Social Security system (0.4 percent) will not be reached.

Thus, it appears likely that this year's public deficit will fall significantly short of the goal. The question is by how much. Pessimistic calculations suggest that it will be between one and one-and-a-half percentage points. What matters is whether the government (present and incoming) has any margin for reducing this gap. Because a shortfall of half a point of GDP would be accepted as inevitable ? and thus not punishable ? by investors. But any significantly greater shortfall would revive the doubts about the Spanish economy's capacity to fulfill the commitments of the stability pact. For this reason it is crucially important that the present government convey a clear, rotund message that the state has public resources at hand to prevent any shortfall that would raise the Spain's risk premium. These resources may consist in the obtaining of extraordinary types of revenue, or in additional adjustments to expenditure.

The transitory difficulty in the correction of the deficit comes up against another stumbling block in the consequences of the probable change in the governing party. A general (bad) habit takes it for granted that the new government will impute both the good and the bad aspects of spending to the period of the outgoing government, so that its own future accounts (and deficit) will look all the better. But times have changed. It will not be advisable for the next government to lean too heavily on accounting dodges, nor to try the patience of the public and the markets with the sad song of the poisoned legacy it has received, because the loss of credibility deriving from such practices will not be easy to live down.

The final deficit for 2011 will be known in February or March. But before that, several direct indications of its quantity will shape investors' decisions. The deficit must be politically managed with extreme care, because the recovery of the economy, which is not possible without private credit and without policies to stimulate demand, will also face considerable added difficulties if the risk premium for Spanish sovereign debt remains at well over 200 basis points.