Government Math May Screw Up Hopes Of Keeping The Euro Humpty Dumpty Together

“The Greek PSI will be resolved one way or the other this week. Early reports suggest a weak start and the triggering of collective action clauses and credit default swaps remain a distinct possibility. Portugal is next and, although the credit dynamics and implementation of reforms is superior to Greece, the risk remains high that it will need a second aid package and/or debt restructuring, as it is unlikely to be able to return to the capital markets in H2 2013. With 2 LTROs and collateral liberalization, the 10-year benchmark in Portugal is yielding more than 13%, compared with a bit more than 12% at the end of last year.

However, the devolution in Spain is particularly troubling. The new fiscal compact had just been signed last week, which includes somewhat more rigorous fiscal rule and enforcement, when Spain’s PM Rajoy revealed that this year’s deficit would come in around 5.8% of GDP rather the 4.4% target. This of course follows last year’s 8.5% overshoot of the 6% target.

The problem that for Spain is that the 4.4% target was based on forecasts for more than 2% growth this year. However, in late February, the EU cuts its forecast to a 1% contraction. This still seems optimistic. The IMF forecasts a 1.7% contraction, which the Spanish government now accepts.
This will be the third year in 5 that the Spanish economy contracts. Unemployment stands at an EU-high of 23.5% in February. The strong export growth seen in recent years, the best growth in the euro area, is stalling. Domestic demand has been hit by rising unemployment and government austerity. At the end of last year, the Rajoy government adopted a 15 bln euro package of spending cuts and tax increases.

Moody’s says that another 25 bln euros in savings is needed for Spain to reach its budget target. Fitch says this is unrealistic and that the overshoot not necessarily impact their credit worthiness.
Spain is already under the excessive deficit procedure (since April 2009), as are 23 of the EU 27 members. Rajoy’s revelations butt against the EU agreement that urged members to adhere to their fiscal commitments. Moreover, Rajoy struck a strident chord by saying he did not communicate this to the other heads of state because he did not have to and that Spain was sovereign….”

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