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Spain's economy is on the edge of a cliff

spain rajoy
spain rajoy


Spain's political troubles are well documented. Two general elections in a year have failed to produce an effective government, with Mariano Rajoy acting as a prime minister in a caretaker government that is pleasing no one.

The country is now staring down another general election before the end of 2016 if no solution can be found for the lack of a functioning government.

So far, Spain's economy has coped admirably with having very little direction in terms of policy and a vast amount of political uncertainty. Unemployment has fallen from 21% at the start of the year to 20% now, and PMI surveys of Spanish industry have picked up in recent months, shrugging off any impact from Britain's vote to leave the EU.

However, HSBC economist Fabio Balboni now argues that the economic impact of Spain's crippling political status could be about to hit, especially if the country fails to ratify a budget for 2017 soon. HSBC essentially argues that should no budget for 2017 be approved, spending will be frozen at 2016 levels, which could, in turn, have a substantial impact on growth in the country next year.

Here is an extract from Balboni's research, circulated to clients on Thursday (emphasis ours):

"The lack of a government might have more serious economic consequences from here. If the 2017 budget cannot be approved by the end of the year, all of the main spending items will be frozen at current levels, including wages and pensions. That would be equal to spending cuts of about 1% of GDP. This might help to reduce the deficit, but it would also have negative consequences for growth. This risk should also provide a strong incentive for the political parties to avoid a third election."

And here is HSBC's handy chart illustrating the timeline for a new budget to be announced in the country:

Spain election timeline
Spain election timeline


To make things even more worrying, Spain is also staring down potential sanctions from the European Union next month over failures to address its budget deficit, and reduce it to levels mandated by Brussels. Spain (along with Portugal) has already swerved EU fines for missing targets, but a new set of negotiations could end in some form of punishment, with the worst outcome being the suspension of structural funds from the EU to Spain. 

As Balboni notes: "In October, Spain also faces a new round of negotiations with Brussels. The biggest risk is the suspension of the EU's structural funds, worth about 1% of GDP. He continues:

"At stake for Spain are not only the financial penalties, which have not been applied by Brussels so far, but also the possible loss of "all, or part of the EU structural and investment funds" (see European Council decision, 8 August 2016). A similar measure has already been applied in the past by Brussels, for example to Hungary in 2012, and in our view is a more credible threat."

While the withdrawal of structural funds and a big fine is a serious threat for Spain, Balboni points out that given the swell of anti-austerity feeling in Europe, as well as growing Euroscepticism, Brussels may be lenient with Spain, if as looks likely, Spain misses its targets. "Given the anti-austerity mood prevailing in Europe at the moment, and the political situation, we don't think the European Commission will be too tough."

Even if this is the case, the continued political uncertainty that wracks the southern European nation could be about to transmit into the economy. Any way you look at it, that is unlikely to be good news.

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