No Leeway from the Punishment Union

As it has recently filtered through that Spain is likely to produce a bigger deficit this year than originally planned, the new European Punishment Union has let it be known that there will be no compromise: Spain is in for a whupping.

As CNBC reports:


“Spain will get no leeway on its budget targets before May, Spanish Economy Minister Luis De Guindos said on Thursday, but Madrid could opt for defiance when it presents the backbone of its 2012 plan on Friday.

Spain has hovered on the fringes of the euro zone crisis as investors worry that its economy, enfeebled by the bursting of a property bubble, puts it at risk of following Greece, Ireland and neighbouring Portugal in seeking a bailout.

Prime Minister Mariano Rajoy, elected last year on a pledge to slash spending, has been lobbying Brussels for leniency, arguing the country's shrinking economy makes it impossible to cut enough this year to achieve a deficit target agreed with Brussels of 4.4 percent of gross domestic product.


Officials in Brussels insist Spain must present a budget based on the 4.4 percent target and that there will be no room for discussions on relaxing it until May.

But a government source said the spending limit Spain would present in Madrid on Friday would be based on a deficit target of 5.3 percent to 5.5 percent, thus breaching the path to cut the deficit agreed with the Commission in 2009.

Spain's Economy Minister Luis De Guindos conceded no resolution was likely before May. "The process has been initiated … In May, we'll have a final decision," he told journalists after talks with euro zone finance ministers in Brussels, where European leaders also meet on Thursday and Friday.

He insisted Spain would keep cutting its deficit, but that toughened economic conditions would make impossible to meet the 4.4 percent target at the end of 2012. "They understand perfectly that the circumstances that led to 4.4 (percent) are not the same any more and that obviously this requires a change," he said.

Spain has restructured its ailing banks, reformed its labour market laws to make it cheaper for companies to hire and fire and threatened sanctions on overspending local governments to try to reassure its bond investors.

On Thursday the European Central Bank's latest handout of cheap 3-year loans to banks encouraged them to buy at a Spanish debt auction, enabling Madrid to borrow 4.5 billion euros at relatively low cost. But in the latest sign that Spain is entering a recession, a survey showed its manufacturing sector shrank for the tenth straight month in February.

(emphasis added)

So not even the old target was met, which should surprise exactly no-one. As we have pointed out about a year ago already, Spain's former government simply shifted the deficit to the regions, which has predictably brought several of the regions close to insolvency. The process is now going into reverse.


'Defiant' Spain

Moreover, Spain has the same problem every other government in the EU now faces: its economy is tanking, and tax revenues are sinking right with it.

The below chart via the WSJ shows the situation:



Spain – the budget gap yawns, while unemployment has reached depression-like levels  (an unemployment rate close to 24%).



The Wall Street Journal has formulated it more bluntly: 'Spain Defies EU on Deficit':


Spain Friday went back on its 2012 budget-reduction commitment to the European Union, highlighting the difficulties of the EU's efforts to tighten control over the finances of its member states. Spanish Prime Minister Mariano Rajoy said his government, which came to power at the end of 2011, will prepare a 2012 budget that aims to reduce its deficit to 5.8% of gross domestic product, far in excess of the 4.4% target his predecessor, José Luis Rodríguez Zapatero, had committed to. Mr. Rajoy said a rapidly deteriorating economic situation and a large 2011 budget overrun made the wide deviation necessary. Earlier this week, the government said Spain's 2011 budget deficit stood at 8.51% of GDP, compared with a target of 6%.

Mr. Rajoy said he hadn't announced Spain's new budget target at a meeting in Brussels Thursday and Friday where EU leaders signed off on new fiscal rules. "This is a sovereign decision made by Spain, that I am announcing now, to you," he said at a press conference.

The Spanish leader, however, said his country is maintaining its commitment of reducing its budget deficit to the 3%-of-GDP limit for EU countries by 2013.”

The new fiscal rules, most of which were agreed to in January, give the European Commission, the EU's executive arm, more power to force governments to adhere to deficit targets. Since Spain has exceeded the 3%-of-GDP limit, the Commission now has considerable discretion whether to seek penalties against the government.

A Commission spokesman suggested Spain shouldn't expect leniency. "Meeting fiscal consolidation targets in vulnerable countries has been and remains one of the cornerstones of EU's comprehensive response to the crisis," said spokesman Amadeu Altafaj Tardio. "It is key to reinforce confidence."


(emphasis added)

Again, we ask what are they going to do? The reality of the situation is that 'paper is patient', as the German saying goes. No matter what agreements are signed and what additional powers the EU now has – on paper – to 'punish' recalcitrant member states, in the end there is no truly viable enforcement mechanism. If the threat of penalties were working, it would have already worked with the old 'Growth and Stability Pact', which has so spectacularly failed.

This problem is almost certain to crop up more often as time passes. All is well while the economy booms, egged on by an expansion of credit and money. Alas, things become dicey once a bust is underway. At the moment, only a precious few of the euro area member nations are actually adhering to the deficit and public debt targets of the Maastricht treaty. It is noteworthy in this context that not even Germany has been able to stock to the rules, in spite of being the country that is now pushing for even stricter fiscal limits.


Credit Market Charts

Below is our customary collection of charts,  updating the usual suspects: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different scales in mind when assessing 4-in-1 charts). Prices are as of Friday's close.

As the case of CDS on Greece heads back to ISDA's ruling committee for a renewed determination whether or not a credit event nee3ds to be declared, the CDS have soared even further, closing last week at nearly 24,100 basis points. CDS on Greece look like the macro-trade of the decade so far, in spite of the fact that there is considerable uncertainty whether in the end, they'll be worth anything at all.

There has also been a blip higher in CDS on Spain, no doubt as a result of the above mentioned altercation with the EU over its deficit target. Otherwise the recent downtrends seem largely intact for now.



5 year CDS on Portugal, Italy, Greece and Spain – click for better resolution.



5 year CDS on France, Belgium, Ireland and Japan – click for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for better resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click for better resolution.



5 year CDS on Romania, Poland,  Ukraine and Estonia – click for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – click for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns – the SovX continues to hold up, as the sharp increase in CDS on Greece outweighs small declines elsewhere – click for better resolution.



Three month, one year, three year and five year euro basis swaps – a small dip on Friday. The euro-land banks are not out of the woods with regards to dollar funding problems – click for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – a  tad higher on Friday – click for better resolution.



5 year CDS on two big Austrian banks, Erste Bank and Raiffeisen Bank – click for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Greek and Portuguese yields continue to levitate, while Italy has seen a major improvement in long term yields last week – click for better resolution.



UK gilts, Austria's 10 year government bond yield, Ireland's 9 year government bond yield and the Greek 2 year note. Austria is back in the market's good graces for now – click for better resolution.



5 year CDS on Australia's 'Big Four' banks – dipping further – click for better resolution.





Charts by : Bloomberg, The Wall Street Journal


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