Brussels further extends Spain’s deficit-reduction deadline

Recognizing that Spain’s worsening economic situation means the government will not meet the strict deadlines to reduce its deficit, the European Commission has agreed to give Spain more time, say sources in Brussels in a move that has been confirmed by the government in Madrid. The International Monetary Fund says the deadline should be extended for two years, while the European Central Bank argues that one extra year is sufficient.

Spain was due to reduce its deficit to 6.3 percent by the end of this year, and then down to 4.5 percent at the end of 2013, and falling below the benchmark figure of three percent in 2014. The government says that it has negotiated with the EU to reach seven percent this year (although the bank bailout pushes the figure above eight percent), and six percent for next year. This would delay reaching the three-percent target until 2015, or possibly 2016. For the moment, the government is saying that it will not have to introduce further spending cuts next year, but will need to making savings equivalent to a percentage point of GDP in 2014 of between 10 billion euros and 15 billion euros.

Next year Germany goes to the polls, making it politically unviable for Berlin and Brussels to approve any measures to stimulate growth. At the same time, Germany is aware of the dangers to its own economy of a continued recession in the rest of Europe. In response, the European Commission has agreed to take the pressure off. France will also benefit, and the Netherlands and Italy may also be given some leeway next year.

The new measures will be officially approved in mid-February. The government says that it will take no decision on asking for a bailout until at least that time, waiting to see the outcome of elections in Italy, and in the hope that the ratings agencies do not further reduce the country’s status.

Under the current deficit objectives, if Spain were obliged to ask for a bailout, the European Central Bank, the European Commission and the IMF would impose new conditions on the government.

“For this reason, unless circumstances change, there is no intention to ask for a help until at least we see a commitment to relax the fiscal objectives,” says a senior member of Prime Minister Mariano Rajoy’s Cabinet. Sources in Brussels go further, saying that if nothing goes wrong in the next two months, Rajoy will definitively park any plans to ask for a bailout, given the political cost involved and the lack of any guarantees that it would help improve Spain’s credit rating.

Austerity remains Europe’s priority. As well as giving Spain more time to reduce its deficit, Brussels is also giving Spain more breathing space to address structural problems. For this reason, the 39.5 billion euros that the EU agreed to lend Spain to prop up its ailing banks, will not be added to the deficit. Equally importantly, the EU is giving Spain the green light to consider some public investment: “Under certain conditions, public investment plans that have a proven impact on the sustainability of public finances [education, or R+D] could be permitted,” says Olli Rehn, the European Commission’s vice president.

Spain is unlikely to find the money anyway, and until the elections in Germany are over — and depending on the outcome — nobody is going to be asking Berlin to agree to release money to help stimulate growth. The European Investment Bank’s hands are also tied. It may have some more room for maneuver in 2013, but so far has not come up with any proposals for investment in the EU’s peripheral states. It has been criticized for appearing to be more concerned about retaining its solvency rating than attempting to kick-start the European economy. Brussels has said that it will do more to get the bank to take the initiative in living up to its name.

The European Commission’s packet of measures also includes a proposal that could further benefit Spain. The last European Summit agreed to set up an EU banking supervisor by March 2014, something that would make it possible to directly recapitalize banks. Spain is about to pump 39.5 billion into the banking system, and Brussels says that this will be enough until the banking supervisor is up and running. In theory, it is even possible for Spain’s banks to recapitalize directly before 2014, as long as the lenders seeking the money agree to supervision by the ECB, although Spanish government sources say that this country’s banks would probably not be eligible.