[author: Robert Kiss]
Despite the best efforts of the Spanish people and Prime Minister Mariano Rajoy, the European Union will almost certainly need to bail out yet another struggling member state. This time it is Spain, the fourth largest economy in the Eurozone. Currently, Spain and Rajoy, are reticent to join the ranks of other member states bailed out by the European Union, European Central Bank, and International Monetary Fund (together known as the “Troika”). However, many credible reports indicate that Spain will soon make a formal request for a government bailout. Thus the PIG bailouts, of Portugal, Ireland, and Greece, will almost certainly become the PIGS bailout, with the addition of Spain. Time will tell if Italy will join the bailout bandwagon.
This potential rescue follows in the wake of the Spanish bank bailout by Brussels this past June. Brussels’ actions in June were an effort to recapitalize struggling Spanish banks. Reduced confidence in the Spanish economy led to an increase in capital transfers from Spanish banks to safer locations such as the UK and Germany. Although Spain does not acknowledge Brussels’ actions this past summer to be a bailout, many see it as a precursor to a much larger and more extensive sovereign rescue this fall. Such a bailout of the Spanish government is a far greater endeavor for the Troika, as the Spanish economy is two times larger than the combined economies of Greece, Portugal, and Ireland.
This September, the President of the European Central Bank, Mario Draghi, announced a bond-buying plan to alleviate the precarious bond yields that countries such as Spain and Italy were receiving. This announcement pushed Spanish bond yields lower, reflecting temporary confidence in the European Union’s commitment to rectify the on going Euro-Crisis. With that being said, Spain needs a bailout. Despite the Spanish people enduring extensive austerity under reforms by Rajoy and his center-right People’s Party (PP), as well as their Socialist predecessors, a bailout is almost certainly necessary.
Currently, Spanish national unemployment is around 25 percent (and over 50 percent for Spanish youth). Along with dismal employment numbers, Spain is suffering from a double-dip recession, and the country is weathering a banking crisis akin to the U.S. experience in 2008. Recent economic forecasts indicate that Spain will not return to growth until 2014. To compound the situation, all indicia point to a general global economic slowdown, with reports predicting that Germany will enter recession this coming January. Since the global financial crisis of 2008, Spain implemented numerous reforms to its economy, including changes to its labor, financial, and banking laws. While these reforms are necessary, long-term solutions to right the Spanish economy, a bailout will provide much needed near-term relief.
Politics and pride are playing into Spain’s delayed acceptance of a bailout. In Greece, Ireland, and Portugal, governments that accepted bailouts from the European Union were voted out of office. Furthermore, Prime Minister Rajoy’s predecessor, José Luis Rodríguez Zapatero and his party PSOE (Spanish Socialist Peoples Party) were defeated handily last November. Their defeat, in part, reflected criticisms of the party’s handling of the Spanish economy. A bailout will reduce Spain’s borrowing costs and provide the country with additional liquidity to address its national and regional budgetary issues. In late September of this year, Rajoy proposed a budget calling for increases in tax revenue and a freeze to civil servant pay, among other measures. Additionally, Rajoy signaled compromise on his campaign promise not to touch Spanish pensions. These announcements coincide with recent requests, by five of Spain’s seventeen autonomous regions, for emergency funds to keep their governments running.
Rajoy’s reluctance to accept a bailout is also caused by the fact that a bailout will likely require Spain to cede some of its sovereignty on fiscal and budgetary policy. An official bailout could come with extensive strings attached, in form of additional austerity, prescribed by the Troika. Rajoy desires to implement austerity in his own way, as control by the Troika tends to lead to social unrest and resistance. If, or more likely, when Spain accepts a bailout, the country’s size as the Euro-Zone’s fourth largest economy will provide it with leverage in negotiations. Spain’s aggressive austerity policies have garnered respect among European leaders. Additionally, protests in Greece, Portugal, and Spain, reflect a growing skepticism that austerity is the only appropriate approach to the Euro Crisis.
Recent domestic events in Spain make it clear that additional action is necessary. In late September, Madrid, Barcelona, and other major Spanish cities witnessed protests. Many of the protestors were the ”indignados” (indignants) – who tend to be unemployed Spanish youth. Along with protests against austerity, nationalistic movements have sprung. In Barcelona, some reports indicate that a late September protest was attended by approximately 1.5 million people. Many of the protestors demanded either greater economic autonomy from Madrid, or complete independence.
On September 27 of this year, the EU created the European Stability Mechanism (ESM) to provide financial assistance to Euro-Zone member states facing financial difficulties. Creation of institutions, such as the ESM and other EU regulators, represents move towards better management of the Euro-Crisis. Until EU and European leaders push for greater integration and cooperation on legal and economic fronts to address the Euro Crisis, countries will continue to face instability. This instability greatly implicates corporate interests in the region. To mitigate potential legal issues in Spain and other Euro-Zone countries, corporations should review existing contracts involving business partners within the Euro-Zone. If possible, renegotiating these contracts could prove beneficial and may address issues such as currency and interest rate fluctuations, changes in financial and banking regulations, the potential exit of a member state, the governing law of the contract, and reallocation of investment risks. New contracts should consider whether counterparties have assets outside a potential exiting EU member state, selecting governing law and venue provisions in favorable jurisdictions, requiring payment in a non-Euro currency or defining what a “Euro” is, incorporating an option to terminate the contract if a member state exits the Euro-Zone, and other such precautions.
In the coming weeks, Spain will almost certainly accept a bailout from the Troika. Spain’s size, political clout, and independent austerity measures, mean the bailout will likely lack many additional austerity requirements. There is a growing sense within Europe, as well as globally, that austerity can only do so much. This fall’s actions by Spain and the Troika will help to shape the future approach to the Euro Crisis. European and IMF officials as well as Spanish leaders must weigh their options carefully, so that the Euro Crisis does not lead to a second global recession.