Rajoy counts benefits of stick-in-mud tactics

Reuters News
Posted: Dec 20, 2012 10:50 AM
Rajoy counts benefits of stick-in-mud tactics

By Fiona Ortiz

MADRID (Reuters) - Brussels may never build a monument to notoriously stubborn Spanish Prime Minister Mariano Rajoy but he has won grudging respect at home and in some quarters abroad for dragging out a request for an EU bailout.

Rajoy has resisted immense pressure from the European Commission, the European Central Bank (ECB), the International Monetary Fund (IMF), Spanish business leaders and even his own cabinet as he seeks the perfect political timing to ask for aid.

Though he long ago built a reputation for caution during his rise from provincial land registry clerk to the top of Spain's center-right People's Party, Rajoy has only been able to delay a rescue because the ECB's pledge to intervene and support Spanish bond prices has put a lid on borrowing costs since the summer.

As a result, Rajoy is under less pressure than six months ago during a big sell-off in government bonds: Spain can still borrow in the market; he has persisted with unpopular budget cuts despite the recession; and his party has weathered several regional elections without suffering the kind of voter backlash it had feared if seen to be going cap in hand to Brussels.

But the gambit has been risky.

With the economy contracting sharply, 25 percent out of work and bond investors' patience not unlimited, Rajoy may miss the opportunity to trigger the recourse to emergency funds in a controlled way, while markets are relatively calm.

If forced to seek bailout by a sudden deterioration in bond market conditions, Spain's finances could spiral quickly into chaos that would make the rescue of the euro zone's fourth economy even more expensive for Germany and other EU states.

Rajoy is testing the limits on the timing of a rescue as he aims to avoid the fate of the leaders of Portugal, Greece and Ireland, who were all forced out of office after seeking aid in return for accepting punishing conditions imposed by lenders.

If he gets most of the dirty work - unpopular spending cuts and labor reforms - out of the way in parliament before seeking a rescue, he could tell Spaniards he has pulled off a "bailout lite", without drastic conditions from Brussels and Berlin.

Rajoy's austerity measures during his first year in office have sparked protests and strikes in professions from subway train drivers to doctors, but he has an absolute majority in parliament so he can stay the course on budget cuts.

France, wary of its own potential vulnerability to market doubts on its budget, has pushed Rajoy to ask for a bailout in recent months. But Rajoy has latched onto the ambivalent line from Germany, where Chancellor Angela Merkel is reluctant about pushing yet another European rescue through the restive Bundestag as she focuses on winning re-election next September.

"Rajoy wasn't facing a unified front pushing him in the same direction," said a senior EU official who spoke on condition of anonymity. "That made it easier for him to stand his ground.

"He was probably right to do so," the official added, arguing that while an earlier bailout might have lowered the spread, or premium over Germany bonds that Spain pays to borrow, Rajoy might have faced more popular anger and other problems.

"Probably the spreads would have been lower if the ECB had intervened," the EU official said. "But there would have been other prices to pay, politically and economically."


Months of talk about a rescue means when it comes it will not be the shock for Spaniards it would have been a year ago.

On the European stage, Rajoy may also benefit from the emergence of powerful voices such as IMF head Christine Lagarde questioning the wisdom of drastic spending cuts that could aggravate Spain's recession. And while he has put off a rescue, Europe has also moved forward with a banking union that will benefit Madrid by offering more shared support for its banks.

In February, the European Commission will decide whether Spain's dire economic circumstances mean it should get more time to cut the public deficit to 3 percent of Gross Domestic Product or below, which it is supposed to hit by 2014.

Jose de Areilza, a professor at Spain's ESADE law school, said that after early missteps Rajoy is communicating better with his European partners: "The negotiation with Brussels is more sophisticated than it seemed, and at this point they are negotiating either a non-rescue or a credit line that hopefully Spain would not actually tap," Areilza said.

Economists say it is difficult to measure how much the delay has cost the government since it is not clear how far borrowing costs would have come down if Rajoy had requested aid from the permanent European rescue fund, or ESM, which would in turn have triggered the ECB's plan to buy Spain's bonds in the market.

Spain's country risk, the premium bondholders demand to buy Spanish 10-year benchmark bonds over German benchmarks, hit a two-month low on Wednesday of 380 basis points, well off dizzy heights above 600 in July.

Rajoy still does not lack critics. Some see more luck than strategic success in the lower spread.

Jose Carlos Diez, chief economist with Intermoney brokerage in Madrid, said the prime minister had left himself with no good options. A request for rescue right now makes little sense since the ECB has refused to meet Rajoy's demands that it guarantee Spain to keep buying to hold the spread at 250 basis points.

But if Rajoy does not jump until too late, forced by a major sell-off in the markets, that could oblige the ECB to absorb more Spanish debt than it is comfortable with: "It is true that Rajoy is in a more advantageous position than he was six months ago," Diez said. "But if you look at the history of debt crises they are only resolved by acting quickly at the beginning."

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High-level Spanish officials say that, faced with having to implement more cuts or go for a rescue, Rajoy will eventually opt for the latter. But, again, at his own pace.

"He doesn't like to take decisions in a state of anxiety,". said a source close to Rajoy, who did not want to be named. "There's a risk - but he's willing to take that."

Rajoy himself has cast doubt on the benefits of a rescue, saying the mechanism Europe has come up with is untried and might not work. This week he maintained his enigmatic line on an aid request, refusing to confirm he will definitely make one.

"We've taken the decision not to ask for it, which does not mean we will not take a decision to ask for it in the future," he told parliament on Wednesday.

Rajoy must consider not only his political priorities at home, however, but also the European political calendar.

Analysts say that if he plays the rescue card when Merkel is deep into campaigning for September's general election, she may have to drive a hard, public bargain over conditions to appease conservative voters who are against bailing out southern Europe.

And if a rescue does not materialize, Spain's debt could be downgraded to junk. Credit ratings agencies have placed Spain on the cusp of junk status and implied they are holding off on the downgrade because they believe a rescue is in the offing.

Many Spanish business leaders complain they have paid a high price for the delay. Blocked from debt markets some have had to sell off assets to cut debt and maintain their creditworthiness.

But others point to Spain's positive balance of payments with the rest of Europe - a measurement that includes trade, investment and financial transactions - and gains in productivity as signs that Rajoy can still afford to wait.

"Rajoy has been wise to delay asking for a rescue," a senior Spanish banker said privately. "We're in the middle of muddling through."

(Additional reporting by Jane Barrett, Paul Day, Sonya Dowsett, Carlos Ruano and Paul Taylor; Editing by Julien Toyer and Alastair Macdonald)