An agreement in principle

The Spanish deficit-reduction objective, recently set by the prime minister at 5.8 percent of GDP for 2012, is hard enough to reach even in conditions of perfect agreement between the different levels of government. But it would be an impossible, indeed implausible, objective if the regional governments were not capable of sticking to strict spending controls and plans for increased revenues.

As such, the agreement announced on Tuesday after a meeting of the Council for Fiscal and Financial Policy, by which the regional governments promised to limit their deficit during 2012 to 1.5 percent (with the abstention of the Canary Islands and Catalonia, and the opposition of Andalusia) is indispensable to the credibility of the stability objective for this year and those to come.

The political jockeying that has surrounded the deficit issue since last week warrants analysis. The government has made clear to Europe its commitment to reduce the deficit this year to 5.8 percent of GDP; this new objective, with or without the blessing of Germany and the Commission, amounts to a clear relaxation of the previously promised 4.4 percent. Such flexibility, meanwhile, is not being applied to the relationship between the central administration and regional governments, when it is clear that many of the latter cannot even come near the indicated 1.5 percent. However, it is also true that without a firm stand and an inflexible application of this objective, it will be impossible to attain the necessary credibility with regard to investors and financial entities concerning the structural deficit commitment for Spanish public administrations as a whole.

On Tuesday Finance Minister Cristóbal Montoro remarked that this was not the right moment to come up with a new system of regional financing. However, this is a need that can only become more pressing with the passage of time. The financing of the public services supplied by the regions is still unresolved. On Tuesday Montoro offered a mechanism for paying the regions’ suppliers, which does not solve the underlying problem; but everyone hastened to accept it. Firstly, it is important that the uncooperative region (Andalusia) should not be adversely affected merely on account of its contrary vote. In spite of the minister’s ominous accusation — “Andalusia is voting against austerity” — it seems reasonable to assume that the Andalusian government is mostly concerned with the survival of basic health and education services. Besides, it is not clear whether the suppliers’ plan will become a burden of debt for the regional governments.

The time is a delicate one for the solvency of Spain’s foreign debt, with new hikes in the Spanish risk premium — stemming, among other reasons, from the distrust that may be aroused by Prime Minister Mariano Rajoy’s modification of the deficit objective. This is not the only cause; but if the government cannot satisfactorily explain, budget in hand, how it is going to fulfill this objective, and that of three percent in 2013, market pressure may rapidly intensify.