Spain's crisis strategy under fire as economy buckles again
Spain’s economy has tipped into an accelerating downturn as sales data and the money supply flash serious warnings, calling into question Madrid’s high-risk strategy of refusing an EU-IMF rescue.
The country's retail sales plunged 10.7pc in December from a year earlier Photo: Alamy
By Ambrose Evans-Pritchard
7:39PM GMT 29 Jan 2013
The country’s retail sales plunged 10.7pc in December from a year earlier as austerity bites deeper, one of the worst months since the crisis began.
The Spanish car lobby (Anfac) said the country’s output of vehicles has fallen below 2m for the first time since 1993, crashing 17pc last year. The industry has shrunk by a third since the boom.
Ominously, car exports plunged even faster at 18pc, dimming hopes that foreign trade can lift the economy out of slump as internal demand shrinks. While Spanish exports have been a bright spot over the past three years - keeping pace with German exports - the momentum has faltered due to lack of investment.
Citigroup said it now expects Spain's economy to contract by 2.2pc this year and another 2pc in 2014, pushing unemployment to 28pc.
The effects of the slump will overpower any gains from fiscal austerity. The bank said public debt will surge from 88pc to 110pc of GDP in just two years.
Professor Luis Garicano from the London School of Economics said the recovery of EMU sovereign debt markets has not fed through to the real economy, leaving Spanish firms starved of credit and investment. “Credit constraints are forcing Spanish companies to eat up their future,” he said.
The loan crunch has put Spanish firms at a “severe competitive disadvantage” with rivals in the EMU-core, further widening the North-South gap. German firms such as Volkswagen are conquering market share across southern Europe by offering cheap credit for sales.
There has been little relief for Spanish firms since the European Central Bank agreed to back-stop Spanish debt in the summer. Private loans contracted by a further €30bn in December alone, even after stripping out distortions.
Prof Garicano said Brussels has made matters worse by forcing the pace of bank deleveraging under the terms of Spain’s bank rescue. “It is too fast. There is a gigantic financial multiplier at work,” he said.
Premier Mariano Rajoy has so far resisted a full rescue from the EU bail-out fund (ESM), fearing a political backlash and loss of sovereignty. Yet the ECB cannot purchase Spanish debt until Madrid pulls the trigger and signs a "memorandum".
Mr Rajoy’s team believe the 250 basis point drop in yields on Spanish bonds since July is enough to restore confidence and drive growth, but economists say this falls far short of actual purchases of debt.
Julian Callow from Barclays said the ECB’s Mario Draghi is “itching” to buy Club Med bonds, seeing this as a way of targeting monetary stimulus on the countries in trouble - without an causing inflationary spillover in Germany - but he is paralysed until Madrid relents.
The current calm may be misleading. Spanish yields have fallen largely because local banks have gorged on Spanish bonds, now deemed safe. This has diverted lending from firms and further entwined the banking system with the sovereign state. This defeats the purpose of EU strategy, which is to break the “vicious circle”.
Monetarists say Spain’s money supply is buckling again after a brief respite in the early autumn, giving an early warning alert of further trouble this year. A key gauge - real six-month M1 - fell 4.5pc in December, while broad M3 has also begun to roll over.
“The ECB must be given the pretext to buy the bonds,” said Tim Congdon from International Monetary Research.
“The critical issue is to raise the quantity of money in Spain. In order to do that the ECB must actually buy things and not just lower rates. They don’t seem to understand this in Madrid. It makes you want to cry,” he said.
Mr Rajoy on Tuesday unveiled a plan of “micro-policies” to revive growth, but the overall setting of fiscal policy is yet further tightening to meet EU deficit targets.
Olli Rehn, the EU economics commissioner, said Brussels is drawing up plans for a “convergence instrument” to help steer investment to crisis countries as a reward for good conduct. But the scheme will not be ready for up to 18 months and is unlikely to be large enough to turn the tide.
Mr Rehn signalled that Madrid may be given more time to cut its deficit. "If there has been a serious deterioration in the economy, we can propose an extension of a country's adjustment path… That's what we did last year in the case of Spain," he said.
The Spanish authorities and the Commission are betting that Spain’s policy of “internal devaluation” and wage cuts within EMU will slash unit labour costs enough to claw back competitiveness, but this is a risky strategy that may overlook the lasting damage to the productive economy - a concept known as "hysteresis".
The US Conference Board said in a report on Tuesday that overkill could backfire in the end. “There is a danger that a drastic lowering of labour costs for an extended period of time could trigger an economic downward spiral,” it said.