Sunday, July 22, 2012

Valencia, Spain: drags the Eurozone Closer to the edge of Collapse despite winning the backing of Finance Ministers

Spain dragged the eurozone closer to the edge of collapse despite winning the backing of finance ministers from the single currency's major economies for a €100bn (£77.8bn) bank rescue fund.

Concerns that Madrid is running out of options to bring down the debts of its ailing banks and bankrupt regions sent the country's borrowing costs soaring above 7.2% – a rate seen as unsustainable for a country that cannot devalue its own currency and is suffering a lengthy double-dip recession.

The bank bailout had been supposed to push down the country's borrowing rates, but the country's problems continue to mount. On Friday the region of Valencia was forced to turn to the Spanish central government for cash help.

That move, together with a downgrade of Spanish bonds to junk status by the credit ratings agency Egan Jones, saw the Madrid stock market suffer its biggest one day fall for two years.

Markets in London, Paris and Frankfurt followed suit with the FTSE 100 falling 1% to 5651. The euro crashed to historic lows against several currencies. Against the pound it fell to 77.72 pence, marking its lowest since the aftermath of the Lehman Brothers collapse in October 2008.

The prospect of Spain standing near the exit to the eurozone with Greece and Portugal had seemed outlandish only a few weeks ago, after eurozone leaders agreed to press ahead with more co-operation and a rescue for Madrid that targeted its banks.

Stock markets climbed and solvency fears eased after the summit, which many saw as provided a lengthy breathing space for politicians to work out a broader rescue package. But the shortcomings of the agreement have once again undermined renewed confidence in the eurozone and sent the bond yields of several countries higher, including Spain and Italy.

Comments by German officials added to the febrile atmosphere with hardliners questioning the eurozone's ability to carry on while southern European countries wrestled with major reforms and public spending cuts.

The Spanish government said a predicted rise in GDP next year of 0.4% had proved optimistic, and the economy would suffer another year of recession. The new forecast that the economy will contract by 0.5% shocked analysts, who said a raft of austerity measures would delay a recovery for several years.

Mariano Rajoy, the leader of Spain's right-wing government, has pushed through €65bn (£50.6bn) of spending cuts and tax rises to meet deficit targets set by Brussels, which are widely blamed for pushing the economy back into recession for another year.

Shortly before the bank bailout was agreed by eurozone ministers on Friday, the Valencia regional government admitted it could no longer fund itself on the markets and requested what is, in effect, a bailout by the Spanish government. Regional governments deliver the key parts of the welfare state, including health, education and social services.

Eastern Valencia said it was asking for central government help as it could not refinance loans that must be paid off this year. Regional vice president José Ciscar did not say how much was needed. "Like other regions, Valencia is suffering the consequences of liquidity restrictions in the markets," he said.

It will become the first of Spain's 17 semi-autonomous regions to tap a new, week-old €18bn (£14bn) fund designed to provide them with liquidity. The fund is part-financed with a loan from the state-owned lottery company.

Valencia, which has long been run by Rajoy's PP, is emblematic of Spain's current crisis. A property crash has hit both regional government income and the region's banks, with its three main banks having to be rescued. Local politicians, meanwhile, have a growing reputation for corruption and frivolous spending.

Valencia mopped up a quarter of the €17bn (£13.2bn) of extra money made available by central government in April to pay a backlog of regional government bills.

Just as Rajoy's government refuses to call the European rescue fund money a bailout, so Valencia's government insisted its request for special funding should not be described as one. "Valencia is signing up to a financing mechanism which other regions will also need in the coming days, without any further measures," Ciscar said.

Last year the regions not only failed to meet government-set deficit reduction targets, but actually increased their joint deficit. Rajoy's government has passed legislation allowing it to take direct control of the finances of regions that stray too far off target.

Analysts believe most regions will miss this year's 1.5 percent deficit target. The government last week asked at least eight of them to revise their 2012 budgets, threatening to take over the finances of some of them.

Analysts at Capital Economics said Spain had suffered a debilitating exodus of funds from its banks and a sharp detioration in its own funding position. As the reliance of the Spanish government on its own banks for funding grows (while the banks themselves are relying on the ECB), so the likelihood of Spain requiring a full-blown sovereign bailout grows too.

European leaders pleaded for calm after signing the final agreement to lend Spain €100bn of funds to underpin its banks.

European Central Bank executive Benoît Cœuré said at a conference in Mexico that it was startling to see international investors fearful of getting their money back from members of the single currency.

However, he said the fundamental measures of economic success were stronger in the eurozone than other developed areas. The eurozone's annual deficit in 2012, he pointed out, is expected to be 3% compared to 8% in the US, and 10% in Japan. He said the eurozone's total public sector debt will reach 90% at the end of the year compared to 106% in the US and 235% in Japan.But his comments were largely ignored as Mariano Rajoy's right wing government went back into crisis mode.

- Guardian UK

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