Risk premium falls to level last seen at time of Zapatero’s 2010 budget cuts

The differential between the Spanish and German benchmark bonds hits 164 basis points That was the level that triggered “the biggest adjustment in democracy” under former Socialist PM

Alejandro Bolaños

There is no shortage of witnesses to Spain’s worst economic crisis in recent history. The story could be told from many angles: the unemployment, the poverty, the inequality, the debt, the businesses that have shut down or the families who have been evicted from their homes, to mention just a few.

But in a constantly mutating crisis, the risk premium – which brings together the markets, the public accounts and the national economy – remains the emergency indicator of choice.

And what it indicated this week is that the tension in the Spanish economy has returned back to 164 basis points, the same level registered in May 2010, shortly before then-prime minister José Luis Rodríguez Zapatero’s own political credit ran out.

They are two identical results that nevertheless have opposing interpretations. The fact that back in 2010 the differential between the yield that investors were demanding to buy Spanish bonds rather than the benchmark German ones – the risk premium – was above 160 meant that the tension had tripled in just five months. It also meant that market skittishness over Greece had spread to Spain.

What really allayed market fears was the European decision to create a bailout fund

“The greatest adjustment in democracy,” as the Socialist administration of Zapatero described it, was introduced in Congress on May 12. But what really, if momentarily, allayed market fears was the European agreement to create a bailout fund.

And yet a figure that was viewed as practically the worst-case scenario turned out to be just the first step down into the pit of the euro crisis, which saw Ireland, Portugal and, again, Greece asking for financial assistance, as Spain teetered on the brink of doing the same.

After the Popular Party (PP) government came to power at the end of 2011, it approved an even bigger budget adjustment than Zapatero's. In June of that year, Prime Minister Mariano Rajoy was forced to ask for a bailout for the banking sector. Even then, market pressure only let up when European Central Bank (ECB) president Mario Draghi announced a commitment to purchase bonds from members in trouble, such as Spain and Italy, if they requested a bailout. Before this statement, Spain’s risk premium had escalated to 640 basis points – 500 is considered the limit the leads into bailout territory.

Only from this perspective, when distrust regarding the future of the euro was at its height, is it possible to understand how a risk premium of 164 basis points would now be shown off by the Spanish government, and even Brussels and the ECB, as evidence of improved financial conditions and the starting point for economic recovery.

The government stopped doing its homework because of upcoming elections in 2012

“What’s really inexplicable is that the risk premium is back where it was in 2010, when public debt has actually doubled,” says José Carlos Díez, who teaches economics at the Icade business school. But it is not only government debt, around 100 percent of GDP, which has deteriorated since then. Unemployment was around 20 percent in 2010 and is now hovering near 26 percent. One million jobs have been destroyed since 2010, to reach three million. When Zapatero announced his adjustment plan, the goal was to reduce the public deficit from 11 percent to six percent of GDP in two years. After the cuts and tax hikes introduced by Rajoy, the deficit has barely dropped below seven percent in four years. And the price of austerity was another recession.

“Europe was wrong to accelerate the exit strategy for fiscal stimulus without the necessary monetary policy. The fact that they are now content with a much smaller adjustment than in 2010 is an acknowledgment of that mistake,” concludes Díez.

The determining factor in reducing the risk premium was not the successive adjustment plans or the reforms, but the intervention by other European governments, and above all the ECB. But Josep Oliver, a professor of economics at Barcelona’s Autónoma University, notes that the Spanish authorities’ decisions do matter when it comes to explaining how recurring market fears over the euro project are addressed.

In just a few months, €350 billion was taken out of the country by nervous Spaniards

Oliver views Zapatero’s adjustment plan as the end of a period of denial. “Since mid-2010 until mid-2011 the Spanish risk premium held its own against the uncertainty generated by the Irish and Portuguese bailouts,” he notes, adding that at this point the economy was growing and job destruction had almost stopped.

“But the government stopped doing its homework because of upcoming elections in 2012. And in the first months after his election victory, Rajoy was confident that the risk premium was dropping because Zapatero was out of office, when in fact it was because of the ECB’s massive auctions,” adds Oliver. As a result, when the euro crisis returned in the spring of 2012, distrust in the Spanish economy had taken hold as rumors circulated that Spain might leave the euro zone and enforce a freeze on deposits – the much-feared corralito.

“In just a few months, €350 billion was taken out of the country, I hope we have learned our lesson,” says Oliver, noting that European elections are drawing near.

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