Spain Deficit Pain Bites Consumers In Prelude To Rajoy Austerity

By Angeline Benoit - Aug 27, 2012 10:26 AM GMT+0400

Mariano Rajoy, Spain's prime minister, speaks during a news conference with 
Mario Monti, Italy's prime minister, in Madrid, Spain.
Angel Navarrete/Bloomberg

Spanish Prime Minister Mariano Rajoy’s austerity drive will intensify this week as a sales-taxincrease tightens the squeeze on consumers whose spending is already plummeting.

The move to raise the value-added tax Sept. 1 will follow a flurry of data showing the pressure building on household finances in the euro area’s fourth-biggest economy, home to a third of its unemployed. Reports due include mortgage lending today, a breakdown of second-quarter gross domestic product tomorrow, inflation on Aug. 30 and retail and current-account data on Aug. 31.

Spain’s government will also release public finance figures illustrating the extent of Rajoy’s challenge as he tries to curb the euro region’s third-largest budget deficit and considers whether to seek further international aid. Consumers have already endured a recession lasting three quarters as a prelude to his tax increase due this week and an annual cut in public wages for the month of December.

“I expect a fairly dramatic weakening of GDP in the third and fourth quarters and further ahead as all components of domestic demand fall,” Ebrahim Rahbari, a London-based Citigroup Inc. economist, said by telephone. “Fiscal tightening will hurt substantially in Spain, and most of its effects are still to come.”

Rajoy last month abandoned his forecast for a return to growth in 2013 as he unveiled spending cuts and tax increases through 2014 that will triple his planned austerity effort to a total of 15 percent of annual gross domestic product. New measures starting in September will add 102 billion euros to the 48 billion-euro adjustment initially planned for this year, which began taking effect in the second quarter.

Deficit Target

The yield on Spain’s 10-year benchmark bond rose to a euro- era intraday record of 7.75 percent on July 25 on investor concern Rajoy may miss his deficit target of 6.3 percent of GDP this year. Spain aims to bring the shortfall within the European Union limit of 3 percent of GDP in 2014. The bond yield was at 6.45 percent as of 4:34 p.m. in Madrid on Aug. 24.

Rajoy’s forecast for a 0.5 percent economic contraction next year is still optimistic, according toRicardo Santos, a London-based economist at BNP Paribas SA, who sees it being three times as deep. He says tax revenue will miss government estimates while unemployment increases, raising the cost of welfare.

“The Greek example shows there is a risk of a downward spiral that can leave the economy stuck in a depression,” said Christian Schulz, an economist at Berenberg Bank in London.

Consumer Squeeze

GDP data tomorrow may show how consumer spending already suffered during the second quarter. The report from the national statistics institute, INE, follows a July 30 estimate showing Spain’s recession worsened with a 0.4 percent contraction. The government forecasts domestic demand will fall 4 percent this year, more than twice last year’s drop.

Mortgage data at 9 a.m. today in Madrid and retail statistics on Aug. 31 will also signal the weakness in household finances. The retail sales figures for July follow a 5.2 percent annual decline in June, while the home-loans report will show whether residential mortgages fell further in June after a 30.5 percent drop from a year earlier in May.

Adding to pressure on consumers is the VAT increase, the second since 2010, which will raise the levy to 21 percent from 18 percent. It’s the first item to take effect as part of Rajoy’s fourth budget-tightening exercise in eight months. Along with a one-month wage cut for civil servants and a reduction in jobless pay, it will account for most of the extra measures he has sought to curb the deficit this year.

Inflation Risk

Higher sales tax risks “exacerbating” the slump in domestic consumption and sparking a spiral in which prices feed wages, said London-based economist Andrew Benito at Goldman Sachs Group Inc., a former Bank of England specialist on consumer spending.

Consumer-price gains are already accelerating. The inflation rate rose to 2.2 percent in July because of higher costs of drugs and increases in local taxes, and probably reached an eight-month high of 2.3 percent this month, according to the median forecast of 10 economists in a Bloomberg News survey.

More tax increases may follow this year as the 17 semi- autonomous regions and over 8,000 municipalities add the cost of a higher sales tax to the adjustments they’ve been assigned that represent 73 percent of the nation’s budget-cutting effort this year. The Madrid subway will raise prices again after increasing its 10-trip ticket 29 percent last May to 12 euros ($15).

Spiralling Costs

The cost of bailing out regions and town halls, along with a backlog of unpaid health-care bills and lower tax receipts, already pushed Spain’s central government to exceed in June its deficit limit for the whole year. The Budget Ministry will release the central government’s balance through July on Aug. 31, before regional second-quarter data is provided in September.

“The data we already have, more than halfway through the year, show it’ll be difficult to meet targets,” said Jose Antonio Herce, a public administrations consultant with Madrid- based firm Analistas Financieros Internacionales. “There is no time to lose to implement all the adjustment measures we can.”

To contact the reporter on this story: Angeline Benoit in Madrid at abenoit4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net