Who Will Save Spain As It Heads Into Another Recession?

Remember how the markets were all heartbroken when the Spanish economy stagnated in Q3 2011? Well, it looks like they’re in for more heartache! According to the latest estimates from the Bank of Spain, the economy probably shrank by 0.3% in Q4 2011.

The Spanish central bank is expecting growth to slip into negative territory because private consumption was quite weak towards the end of 2011, as evidenced by a drop in car and retail sales.

Not only are they forecasting gloomy results for the last quarter of 2011, but they also expect the economic weakness to carry over well into 2012. As a matter of fact, they say that the economy could contract by up to 1.5% this year!

Looking at the state of things in Spain, I can say that’s not impossible. After all, the unemployment rate was at 21.5% in Q3 2011, a ridiculous level by any standard, and they say it could climb as high as 23.4% this year as Spain adopts austerity measures to meet its budget. That being the case, it’s not a far stretch to say that back-to-back quarters of negative growth and a double-dip recession could be lurking right around the corner.

So who will step up to save the day and the economy? Well, we have a couple of candidates from the Finance Ministry in mind.

Hero

If you recall, Spanish Prime Minister Mariano Rajoy divided the Finance Ministry in two after coming to power in December. On one hand, he placed Cristobal Montoro as the new Budget Minister to take charge of the national budget. And on the other hand, he assigned Luis de Guindos the role of Economy Minister, responsible for the national economy.

Cristobal Montoro

The first candidate is a man who has been in Spain’s political arena for as long as Cyclopip has been dateless, Cristobal Montoro. Being the appointed Budget Minister, SeƱor Montoro argues that the government should focus on growth. In other words, he is saying that the country should take it easy on its austerity measures. In fact, he even called for the EU to revise its deficit goal for Spain, por favor.

What was he thinking, you ask?

You see, the targets for Spain to reduce its deficit to 4.4% in 2012 and 3.0% in 2013 were established during the time of the previous Socialist government and were based on the assumptions that the Spanish economy would grow by 2.3% in 2012 and 2.4% next year.

Now, with talks of a double dip recession in the cards for the euro zone‘s fourth largest economy, he argues that the latest forecasts have to be taken into consideration and must be made “realistic.” Some analysts agree with him and say that Spain would be better off with a debt-to-GDP ratio goal of about 5.5%-6.0% for 2012.

Luis de Guindos

The Economy and Competitiveness Minister Luis de Guindos doesn’t agree with Montoro, though. In a statement issued earlier this week, he said that the government will stick to its deficit goal NO MATTER WHAT.

The former Lehman Brothers Spain CEO said that the country’s commitment to its target would only prove that the new government is “superior” to the old one under Jose Zapatero. And besides, it is already anticipated that Spain’s deficit for 2011 overshot the 6.0% forecast and would probably come in higher at 8.0%. That’s enough bad news as it is, and backing out of its promise to implement budget cuts and increase taxes would only make Spain look bad to investors.

So who will be Spain’s champion?

While Montoro’s plan appears more favorable to the public, that of De Guindos seems to have won the favor of investors and the Prime Minister. Deputy Prime Minister Soraya Saenz de Santamaria issued a statement saying that the government has no plans of veering away from its deficit reduction target. If more reform is needed to meet the 4.4% goal for this year, then more austerity measures will be implemented.

Some market junkies did the math and estimate that the government’s plan to cut spending by 8.9 billion EUR and increase taxes to generate around 6.3 billion EUR would cost an average Spanish worker about 2,000 EUR in 2012. Yikes! That’s a lot of money that could instead be used for consumer spending and contribute to economic growth, wouldn’t you say?

I understand the government’s concern that cutting back on its deficit target may give investors one more reason not to buy Spanish government bonds and send yields higher. However, perhaps the austerity measures they have in mind are a bit too much.

Don’t get me wrong, I give Finance Minister De Guindos props for wanting Spain to stick to its goal. But could it be that he is only setting the country, as well as the markets, up for more disappointment by setting expectations too high?