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Sunday, February 14, 2010

Just What Is The Real Level Of Government Debt In Europe?



“If you don’t fully understand an instrument, don’t buy it.”

To the above advice from Emilio Botín, Executive Chairman of Spain’s Grupo Santander, I would simply add one small rider: Don’t sell it either, especially if you are a national government trying to structure your country’s debt.

In a fascinating article in today's New York Times, journalists Louise Story, Landon Thomas and Nelson Schwartz begin to recount the mirky story of just how the major US investment banks have been able to earn considerable sums of money effectively helping European governments to disguise their growing mountain of public debt.
Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.


In fact, concerns about what it is exactly Goldman Sachs have been up to in Greece are not new, and the Financial Times have been pusuing this story for some time, in particular in connection with the investment bank's ill fated attempt to persuade the Chinese to buy Greek government debt (and here, and here). Nor is the fact that the Greek government resorted to sophistocated financial instruments to cover its tracks exactly breaking news, since I (among others) have been writing about this topic since the middle of January - Does Anyone Really Know The Size Of The Greek 2009 Deficit? - following the arrival in my inbox of a leaked copy of the report the Greek Finance Minister sent to the EU Commission detailing the issues.

What is new in today's report from the NYT team is the extent to which they identify the problem as a much more general one, involving more banks and more countries, since "Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere". I very strongly suggest that our NYT stalwarts take a long hard look at what has been going on in Spain, and especially at the Autonomous Community level.

So the question naturally arises, just how much in debt are our governments, really? As the NYT team point out, Eurostat has long been grappling with this matter, and as far back as 2002 they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of many off-balance sheet entities that had previously escaped detection by the EU, since up to that point the transactions involved had been classified as asset "sales", often of public buildings and the like. Following advice paid for from the best of investment banks many European governments simply responded to the rule change by reformulating their suspect deals as loans rather than outright sales. As we say in Spain "hecha la ley, hecha la trampa" (or in English, when you close one loophole you open another). According to the NYT authors:

"As recently as 2008, Eurostat.... reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”"

So just what is all the fuss about. Well, in plain and simple terms it is about an accounting item known as "receivables". Now, according to the Wikipedia entry:

"Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of a customers for goods and services received by the customers. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms."


However, as we can learn from another Wikpedia entry, often the use of "accounts receivable" constitutes a form of factoring, and this is where the problems Eurostat are concerned about actually start:

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.


But how does all this work in practice? Well, the World Wide Web is a wonderful thing, since you have so much information near to hand, at just the twitch of a fingertip. Here is a useful description of what are known as PPI/PFI schemes, from UK building contractor John Laing:
A Public Private Partnership (PPP) is an umbrella term for Government schemes involving the private business sector in public sector projects.

The Private Finance Initiative (PFI) is a form of PPP developed by the Government in which the public and private sectors join to design, build or refurbish, finance and operate (DBFO) new or improved facilities and services to the general public. Under the most common form of PFI, a private sector provider like John Laing will, through a Special Purpose Company (SPC), hold a DBFO contract for facilities such as hospitals, schools, and roads according to specifications provided by public sector departments. Over a typical period of 25-30 years, the private sector provider is paid an agreed monthly (or unitary) fee by the relevant public body (such as a Local Council or a Health Trust) for the use of the asset(s), which at that time is owned by the PFI provider. This and other income enables the repayment of the senior debt over the concession length. (Senior debt is the major source of funding, typically 90% of the required capital, provided by banks or bond finance). Asset ownership usually returns to the public body at the end of the concession. In this manner, improvements to public services can be made without upfront public sector funds; and while under contract, the risks associated with such huge capital commitments are shared between parties, allocated appropriately to those best able to manage each one.


And for those still in the dark, Wikipedia just one more time comes to the rescue:

The private finance initiative (PFI) is a method to provide financial support for "public-private partnerships" (PPPs) between the public and private sectors. Developed initially by the Australian and United Kingdom governments, PFI has now also been adopted (under various guises) in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States (amongst others) as part of a wider program for privatization and deregulation driven by corporations, national governments, and international bodies such as the World Trade Organization, International Monetary Fund, and World Bank.

PFI contracts are currently off-balance-sheet, meaning that they do not show up as part of the national debt as measured by government statistics such as the Public Sector Borrowing Requirement (PSBR). The technical reason for this is that the government authority taking out the PFI contract pays a single charge (the 'Unitary Charge') for both the initial capital spend and the on-going maintenance and operation costs. This means that the entire contract is classed as revenue spending rather than capital spending. As a result neither the capital spend nor the long-term revenue obligation appears on the government's balance sheet. Were the total PFI liability to be shown on the UK balance sheet it would greatly increase the UK national debt.


And here are two more examples of what is involved which were brought to light by a quick Google. First of all, the case of Italian health payments. Now according to analysts Patrizio Messina and Alessia Denaro, in this report I found online from Financial Consultants Orrick:

In the last years many structured finance transactions (either securitisation transactions or asset finance transactions) have been structured in relation to the so called healthcare receivables.The reasons are several. On one side, the providers of healthcare goods and services usually are not paid in time by the relevant healthcare authorities and therefore, in order to gain liquidity, usually assign their receivables toward the healthcare authorities. On the other side, due to the recent legislation that provides for very high interest rates on late payments, the debtors as well as banks and other investors have had the same and opposite interest on carrying out different kind of transactions. In this brief article we will analyse, after a quick description of the Italian healthcare system, some of the different structures that have been used in relation to transactions concerning healthcare receivables and, in particular, we will focus on transactions concerning the so called “raw receivables”, which are lately increasing in the Italian market practice, by analysing the legal means through which it is possible to ascertain/recover such receivables.


This system thus has two advantages (apart from the fact that it effectively hides debt). In the first place the healthcare providers gain liquidity in order to continue to run hospitals, pay doctors, etc, while those who effectively intermediate the transaction earn very high interest rates for their efforts, interest payments which have to be deducted from next years health care provision, and so on.

As the Orrick report points out, Italy’s national healthcare service (servizio sanitarionazionale, “nhs”) is regulated by the legislative decree of December 30, 1992, no. 502 (“decree 502/92”).The reform introduced by decree 502/92, as amended from time to time, provides for a three-tier system for the healthcare service, as outlined below: State level The central government provides a national legislation limited to very general features of the NHS and decides the funds to be allocated to the single regions according to specific criteria (density of population, etc.) for the NHS.

As the Orrick analysts note: "the Healthcare Authorities usually pay the relevant Providers with a certain delay".
Usually, when healthcare funds are allocated, in the national provisional budget, the central government underestimates the amount of healthcare expenditure. Since the central government does not provide regions with enough funds, regions are not able to provide enough funds to Healthcare Authorities, and payments to the Providers are delayed. Since the Providers need liquidity, they usually assign their receivables toward the Healthcare Authorities. To deal with all the above issues, Italian market practice has been developing an alternative system of financing through securitisation and asset finance transactions of Healthcare Receivables.


As the analysts finally conclude:

Despite of the risks concerning the judicial proceedings, Italian market players are still very interested on carrying on securitisation transaction on this kind of asset, principally because Legislative Decree no. 231/02 provides for very high interest rates on late payments (equal to the interest rate applied by ECB plus 7%) - my emphasis


Another technique Eurostat have identified as a means of concealing debt relates to the recording of military equipment expenditure, as described in this report I found dating from 2006. At the time Eurostat were worried about the growing provision of military equipment under leasing agreements. Basically they decided that such provision was debt accumulable.
Eurostat has decided that leases of military equipment organised by the private sector should be considered as financial leases, and not as operating leases. This supposes recording an acquisition of equipment by the government and the incurrence of a government liability to the lessor. Thus there is an impact on government deficit and debt at the time that the equipment is put at the disposal of the military authorities, and not at the time of payments on the lease. Those payments are then assimilated as debt servicing, with a part recorded as interest and the remainder as a financial transaction.


However, a loophole was found in the case of long term equipment purchases:



Military equipment contracts often involve the gradual delivery over many years of a number of the same or similar pieces of equipment, such as aircraft or armoured vehicles, or including significant service components, such as training. Moreover, in the case of complex systems, it is frequently the case that some completion tasks need to be performed for the equipment to be operational at full potential capacity. Some military programmes are based on the combination of several kinds of equipment that may be completed in different periods, so that the expenditure may be spread over several fiscal years before the system, globally considered, becomes fully operational.

In cases of long-term contracts where deliveries of identical items are staged over a long period of time, or where payments cover the provision of both goods and services, government expenditure should be recorded at the time of the actual delivery of each independent part of the equipment, or of the provision of service.


Payment for such items are only to be classifed as debt at the time of registering the actual delivery, which may explain why, if my information is correct, the Greek military as of last December were still officially "testing" two submarines which had been provided by German contractors, since final delivery had still to be formally registered, and the debt accounted.

A lot of information about the kind of things which were going on before the 2006 rule change can be found in this online presentation from Europlace Financial Forum. Here are some examples of private/public sector cooperation in Italy.



And here's a chart showing a list of advantages and possible applications:



Now, at the end of the day, you may ask "what is wrong with all of this"? Well quite simply, like Residential Mortgage Backed Securities these are instruments that work while they work, and cause a lot of additional headaches when they don't. I can think of three reasons why debt aquired in this way in the past may now be problematic.

a) they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. Following the crisis these previous levels of assumed growth are now unlikely to be realised.
b) they assume growing workforces and working age populations, but both these, as we know, are now likely to start declining in many European countries.
c) they assume unchanging dependency ratios between active and dependent populations, but these assumptions, as we also already know, are no longer valid, as our population pyramids steadily invert.

Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.

And if you want one very concrete example of how unsustainable debt accumulation can lead to problems, you could try reading this report in the Spanish newspaper La Verdad (Spanish, but Google translate if you are interested), where they recount the problems being faced by many Spanish local authorities who are now running out of money, in this case it the village of San Javier they have until the 24 February to pay a debt of 350,000 euros, or the electricity will simply be cut off! The article also details how many other municipalities are having increasing difficulty in paying their employees. And this is just in one region (Murcia), but the problem is much more general, as Spain's heavily overindebted local authorities and autonomous communities steadily grind to a halt.

Thursday, February 11, 2010

Chart Wars

A new kind of battle is going on out there at the moment. In what must surely be a new twist to the old dialectic of blow against blow argument, a combination of the internet age and sophistocated data management software is adding an additional and striking dimension to the current crisis debate, let's call it the birth of the "charts war". I think you could safely say Paul Krugman kicked off the latest round off, with this simple blog image post.




The Kindom of Spain was not amused, and struck back in their London roadshow (courtesy of Elena Salgado and Manuel Campa) with their own version of the same issue.



Spain, we are informed is not so badly off, since Italy's position is much worse. Even more to the point, adding 3 million or so unskilled workers to the dole queues, and closing down a large chunk of Spain's core construction industry (driving the unemployment rate up to 19.5% in the process) has been extremely beneficial, since cleaning out all those low productivity, unskilled workers has meant that the productive power of the rest looks a lot better (since average productivity of those in work has risen). But isn't this just where the fiscal deficit issue comes in? These workers are still being supported by the rest via the Spanish system of employment benefits, so the productivity improvement (as far as Spain as a whole is concerned) is simply an optical illusion.

This is a point that Krugman could have picked up on but didn't, although he did follow through with a further post full of very revealing charts. The core issue here is that the problem Spain faces, as Paul stresses, is not essentially a fiscal one, a point which may be clearly seen in the following comparison of German and Spanish fiscal deficits over the last decade.



As he shows, Spain had no fiscal problem till the housing boom went bust. No of course, the need to prop up the economy, and support all the "unproductive" labour which doesn't show up in the unit labour costs chart is producing a massive fiscal deficit. Thus the fiscal issue in Spain is a symptom, not a cause. The root of the problem lies in the structural distortions produced by the massive overheating of the economy during the boom years, an overheating which lead to excessive inflation, large-scale dependence on imports, and a complete loss of competitiveness in the non-tradeable sector - a loss of competitiveness which even the Kingdom of Spain accept.The problem with the Spanish argument is that it seems to neglect the rather inconvenient fact that those workers who are deployed in the tradeable sector also eat bread and go to hairdressers and ride in taxis and buy or rent homes just like everyone else. So they themselves need to pay prices set in the non-tradeable sector, and their salaries have to reflect this. Hence a problem in non-tradeables becomes a much more general one. And it shows up, naturally enough, in the current account balance.





Of course, just as there is more than one way to peel an onion, there are a variety of different ways to measure competitiveness (GDP deflator, unit labour costs, etc). My own favourite back-of-the-envelope measure is what is known as the Real Effective Exchange Rate (REER, which shows at roughly what sort of virtual rate the Peseta would trading with the Deutsche-mark (were the two still to exist, of course).



Smokin' Gun

Indeed, analysts at PNB Paribas recently took the REER argument one step further, and showed how, far from addressing the competitiveness issues in Greece and Spain the recent bout of fiscal spending was in fact making the situation worse.


This is a point I have been trying to make in a number of recent posts by using two simple charts. The ECB eased liquidity in the Spanish banking system last June with a massive injection of one year funding.



This money went, via bank purchases of Spanish Treasury Bonds, to fund the government deficit, leading to a large injection of demand into the real economy. But what happened to that demand? Just look at the chart below. The trade deficit started to widen again, as Spaniards availed themselves of their additional spending power to buy yet more foreign products.



So essentially the issues is this one. Spain's economy will not recover, and return to growth till Spanish products become more attractive in price terms, and this only means one thing: some sort of internal devaluation is inevitable, and all the talk about an exclusively fiscal correction is simply an attempt to get rid of the smoke without going to the trouble of extinguishing the fire which is producing it.

Wednesday, February 03, 2010

Spain's Incredible Consumer Confidence Index

According to Spain's Instituto de Crédito Oficial (ICO) the ICC-ICO (consumer confidence index) went up in January by 6.1 points from its December value and is now at its highest level since August 2009. This confidence improvement is largely due to a significant rise in the Expectations Indicator (+5.7 points) and to a smaller one in the Current Economic Conditions one (+2.3 points).

As can be seen from the chart below, confidence while up, is not exceptional by historic standards, which is hardly surprising given the deep recession which Spain is in.




What is really striking - nay astonishing - is that when you come to look at the breakdown of the index into its components (see chart below) you find that the bulk of the work is being done by the expectations indicator, which at 108.5 is now showing its second highest reading ever, and only just below the all time series high of 109.7 which was hit back in the heady days of January 2005! (The indicator series only goes back to September 2004).




This is not only incredible, it is extraordinarily hard to understand. Even those who doubt that the situation is quite as bleak as people like me argue it is must surely admit that Spain now faces a difficult and testing time. My contention is not that there is anything wrong with this finding, but rather that this is how Spanish people actually think at the present time. They have no idea of the actual economic reality, or of what the future has in store for them. They are virtually being kept in the dark. This is the worrying part, and I fear that all this may well now end badly, very very badly.

Tuesday, February 02, 2010

Spain Is A Serious Country

José Luis Rodríguez Zapatero, Spain’s prime minister, said in Davos this week: “We are a serious country and we will fulfil our promises.”


With these words Spain's Prime Minister sought, during his visit to Davos last week to reassure international investors that Spain, despite the severity of the recession it is currently suffering, and the major challenges facing its banking system, is not about to become another Greece.

Just to prove the point he had Labour Minister Celestino Corbacho and Economy Minister Elena Salgado announce in short order that a) Spanish citizens are going to work two more years each in the longer term, and b) face continuing and sweeping cuts in services and increases in taxes in the short term. The trigger for this rather unexpected show of determination seems to have been the growing danger of contagion from debt crisis worries in Greece, as Spanish 10 year bonds spreads nudged briefly through the 100 base point level over the comparable German benckmark. Unfortunately, enthusiasm for the new-found seriousness doesn't seem to have lasted long, since this just morning (and only three days after that strong demonstration of will for change) the Spanish press inform us that Elena Salgado - faced with strike threats from the main trade union organisations - is having second thoughts, and is willing to be "flexible", since the proposal for pension reform, was only that, a proposal which is up for negotiation.

Spain's banks have extensive government bond holdings, and as the spread rises the market value of these bonds falls, so - given that another important part of the banks capital base is composed of land and property assets of uncertain value - the prospect of a slide in the value of the bonds they hold leaves Spain's government with little alternative but to be seen to be taking "serious" measures, whatever the cost. But quite how Spain's citizens will react to the news that their government's policy is now being driven by the need to "calm market fears", and that the country's leaders are actively considering asking them to retire at 67, still remains to be seen. Yesterday's warning shot from political rivals and unions alike may leave their mark in the short term, but it is now clear that things have, in fact, changed, and Spain's politicians (and the bankers who influence them) are now likely to be much more sensitive to market sentiment than they are to public protest.


The Economic Slide Continues

While eurozone manufacturing sector grew at its fastest pace in two years in January, the divergence between laggard Spain and the rest of the big four economies simply widened, according to yesterday's Global Manufacturing PMI report. Spain was actually (and just one more time) the worst performer among the 26 countries surveyed. Here in Europe the Markit eurozone manufacturing purchasing managers’ index for January rose to 52.4 from 51.6 in December, but while the data showed activity in Germany, France and Italy continued to expand it was a different story in Spain, where the reading did edge up slightly to 45.3, from 45.2 in December in a move that offered little more than token consolation, since the changes is marginal, and simply confirmed that business conditions in manufacturing deteriorated for the twenty-sixth successive month.


“The recovery is becoming two-track, with Spain and Greece in particular falling further into recession when growth in most of the other nations, led by France and Germany, is accelerating,” said Rob Dobson at data provider Markit.





Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit, said:

“The Spanish manufacturing sector began the new year with output, new orders and employment all continuing to fall. The steepest decline in input buying for seven months highlights the lack of confidence in the sector, with firms reluctant to invest in new stock until sales have been secured. Manufacturers were again forced to cut prices in January as weak demand made it difficult to pass on higher raw material costs to clients.”

Again,Spanish car sales rose 18.1 percent in January comp.ared with the same month of last year, but these sales are destined to fall back sharply in the second half of this year as government subsidies are withdrawn. According to car makers' association ANFAC the January sales increase followed a rise of 25.1 percent in December and 37.3 percent in November. Year on year car sales fell 17.9 percent in 2009 (over 2008) to 952,772 vehicles.

The Spanish government began offering 2,000 euro subsidies to new car buyers last May, in addition to a 700 million euro subsidy to replace old cars with energy-efficient models, but this kind of spending is simply likely to disappear as the government moves forward with its austerity programme.


As ANFAC noted, "The continuation of government subsidies is having a positive influence on car sales........in the second half of the year sales will benegative, with falls over 18 percent as a result of the 2 percentage point rise in VAT and an end to government subsidies."

Unemployment Still Heading Onwards And Upwards

As the PMI report points out, Spanish manufacturers continued to adjust their workforces in response to extensive spare capacity during January, resulting in further substantial job cuts. Employment in manufacting has in fact now declined in each and every month since September 2007.

Not unexpectedly, the number of workers registered as unemployed in Spain increased by 124,890 in the month of December, and is now over the 4 million mark (4.05 million), according to Labour Ministry data out today (Tuesday). Since January last year, the number of registered jobless has risen by 720,692.

According to Maravillas Rojo, head of the Labour Ministry's employment department, "January is traditionally a bad month for unemployment. Historically it rises in that month even when the economy is growing". She added that "The rise in joblessness is a very bad figure, but the tendency for the rise to slow, which began about a year ago in March, continues, although we have yet to hit the ceiling". And the rate of increase is slowing (see chart below), although there is a marked increase in people who are not registering, and the government deficit adjustment plan will surely start to add to the queues again.




In addition to the rising unemployment figure, the number of taxpayers to the Social Security system has also fallen starkly: there are 257,828 less of them (more than doubling the unemployment figure increase). Such a number implies that, apart from the expected people retiring and in retraining courses, there are many entrepreneurs that are shutting down their businesses. Let us recall that on January 2008, even though the fall in unemployment was similar (132,378), the number of taxpayers affiliated to Social Security was only reduced by 84,697.

The psicological threshold of 4 milion people unemployed has now been broken, with a grand total of 4,048,493. Let us recall the Minister Corbacho asserted repeatedly last year he "did not believe" Spain would reach the figure of four milion people unemployed.

Today's unemployment figures illustrate we are now in the second phase of the current crisis, since we have gone beyomd the first credit-shock part (which induced layoffs mainly in the construction sector) and are into the second, provoked by the sharp reduction in global output, and now continued by an ongoing drop in internal consumption. The evidence for this is the fact that most of the new unemployed belong to the services sector (102,130 (a monthly increase of 4.5%) and the industrial sector (8,873, monthly increase of 1.7%). Construction "only" added 7,036 layoffs (0.9% monthlyincrease).
Jordi Molins, independent Catalan economist.



So 4.05 million is just the number of people who are signing on at the labour offices, on other measures the level of unemployment is even higher. According to Eurostat data (ILO comparable methodology) there are around 4.5 million unemployed already, not counting those who have already left Spain in the search for work elsewhere (the so called "discouraged" workers). According to the latest Eurostat data the seasonally adjusted unemployment rate for European Union member states (EU-27) was 9.6 percent in December 2009, compared with 9.5 percent in November.

Among member states, the lowest unemployment rates were recorded in the Netherlands at four percent and in Austria at 5.4 percent, and the highest rates were seen in Latvia at 22.8 percent and in Spain at 19.5 percent (see chart). Spain thus ended 2009 with the highest jobless rate in the Eurozone, and by a large margin.




Elena Salgado Fails To Convince

According to the FT's Victor Mallet Elena Salgado was unable to conceal her discomfort last week, when she met the press to announce her austerity plan designed to slash successive budget deficits and restore the country’s credibility on international markets. Ms Salgado "had good reason to be uneasy. The table of figures she presented on Friday showing Spain’s “fiscal consolidation path” through €50bn of savings over four years had some embarrassingly blank spaces for the projected budget deficits in 2010, 2011 and 2012".

Spain, as Mallet points out, wants to reduce its total public sector deficit from 11.4 per cent of gross domestic product in 2009 to the European Union target of 3 per cent of GDP in 2013, but - as the empty boxes show - is not sure either if it can, or how to do it. Alfredo Pastor, a professor at IESE business school in Madrid and former deputy finance minister, shares the same doubts: Spain will also struggle to reach the EU deficit ceiling by the 2013 deadline, “We would have to have very high and fast growth, higher than what we can expect,” he told Bloomberg in an interview last week.





"It's a plan that is essential after our most recent deficit figures," Finance Minister Elena Salgado told journalists at the meeting which followed the government's weekly cabinet meeting. But the main problem facing the Spanish government now is credibility. Spain announced an annual deficit of 11.4% for 2009 after previously (even two weeks ago) forecasting the deficit would come in at 9.5% of GDP. In fact it is rather surprising that as recently as last September (when the government first presented its budget plans for 2010) the deficit was still being forecast to come in as low as 5.2% of GDP (52 billion euros), while by November the forecast had already risen to 8.5% of GDP (85 billion euros) and now (just two months later) we are told that it was 11.4% (over 110 billion euros). A number of questions automatatically arise, like just what level of control the Spanish government actually has over its deficit, and just how convincing is the government's plan to make a three year, 50 billion euro reduction in a deficit which has just shot up in four months by more or less exactly the same amount without anyone (officially) forseeing it!

And Elena Salgado's still incomplete deficit reduction plans critically depend on economic growth forecasts – which rise to about 3 per cent a year in 2012 – that many independent economists regard as totally unrealistic. Even the IMF, with whom Ms Salgado recently took issue, are not convinced by her numbers and forecast a 0.6% (and not a 0.3%) contraction this year. The government now projects a 1.8% gain in GDP in 2011, with growth in 2012 up as high as 2.9%, from a prior 2.7%. Of course, you can pull numbers (like rabbits) out of any hat you like, but that won't bring you growth, and certainly not nearly 3% growth in 2012.

"We are moderately optimistic for 2010 and 2011," Elena Salgado said "If you recall, in June, international agencies also forecast the worst, ultimately, convergence has been to our data" she added.


How she has the temerity to say this is really beyond me.

So even after Friday’s announcement serious doubts remained about Spain’s ability to control its budget spending, particularly since a fifth of the proposed adjustment is supposed to come from the autonomous regions and local authorities that account for more than half of spending. The central government, furthermore, specifically ruled out cuts in pensions, unemployment and social security payments, education spending, research and development or foreign aid. Half the deficit reduction is to come from spending cuts, including a near-freeze on hiring for the civil service (only one in every ten who leave is to be replaced). This means central government, which will bear the load of the austerity plan, about 40 billion euros of it, or 5.2% of GDP.


As is well known Spain is currently grappling with the collapse of a decade-long housing boom that has pitched the wider economy into a deep recession, sent tax revenues plummeting and social welfare costs soaring. Furthermore, in the aftermath of the housing bust, even the government doesn't expect the economy to return to pre-crisis growth rates anytime soon, making it impossible to meet spending commitments taken on during the boom years. Even more worryingly, despite the fact that the pension reform is needed, and the austerity programme to rein-in the deficit essential, Spain has not one measure currently on the table which is able to restore growth and employment in the short term.

And time is running out. As Victor Mallet puts it - the recent austerity announcement does little answer the one question which is now uppermost in the minds of all those investors and economists who are busy worrying themselves about the future of Europe: can Spain control its budgets and once more become competitive within the constraints of the single European currency?

Mr Zapatero insists it can – “We are a serious country and we fulfil our promises,” he said in Davos – but he and Ms Salgado have yet to prove it, and today's news that the retirement plans may well be substantially modified only serves to reinforce the doubts.