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Western EuropeJune 4 2006

Political battles dog progress

Spain’s government seems more focused on social policy and political pandering than on the tough reforms that are needed to keep the economy flourishing. Karina Robinson reports from Madrid.
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It is rare to find a society that is as bitter and divided as that of Spain today, even as economic growth far surpasses that of its neighbours, foreign policy is more in accord with the wishes of the majority and there are the strongest hopes ever that Basque terrorism under the auspices of ETA may be coming to an end.

The government’s proposed talks with ETA are contentious and a statute of autonomy for Catalonia is, according to the opposition, “breaking up Spain”. A hostile bid in the energy sector epitomises two business sectors that are at odds with each other.

Although prime minister José Luis Rodríguez Zapatero’s poll ratings are at a high due to hopes of an end to ETA’s violence (polls that were admittedly gathered before a further bomb explosion in April), sparking a hope among some economists of a push on reforms, most believe that with elections two years away, the government will shirk any major reforms.

“The government has the correct diagnostic [of the economy’s problems]. But drastic reforms are difficult when things are going so well,” says Alejandra Kindelán, chief economist at Grupo Santander.

Social leaning

Not only is it tough to convince an electorate of the need for painful reform when the economy is booming, but also Mr Zapatero is more interested in social policy than the economy, unlike his predecessor José María Aznar, a former tax inspector.

The prime minister has been busy bringing Spanish policy up to date – even ahead of some EU partners – by legalising gay marriage, granting same-sex couples the right to adopt children, passing a law on social assistance for those in need, making divorce easier, legalising stem-cell research and passing a bill that increases family-friendly policies.

In addition, on the economic front, the two policy-makers in government are at odds with each other, say bankers and economists. Pedro Solbes, the well-respected finance minister who held this job in the 1990s, appears to have taken second place to Miguel Sebastián, the prime minister’s economic adviser, who is based at the Moncloa Palace headquarters with Mr Zapatero and appears to be a more interventionist, less orthodox economist. Mr Sebastián is mooted to be the next finance minister if the Socialists win the elections.

Economic growth

The good news is that unemployment, at 8%, is at an historic low and the economy is expected to grow at 3.1% this year following growth of 3.4% last year, far above the eurozone’s 2%, with both investment and consumption growing. Spanish companies are reporting record average profits and targeting foreign ones (see capital markets feature, page 70). There is a budget surplus of 1.1% of gross domestic product (GDP). Meanwhile, the boom in mortgages appears to be slowing to a more manageable level, from growth of about 25% last year to less than 20% this year, to estimates of about 10% for 2008.

Jesús Martínez, director of financial services at S&P Rating Services in Madrid, believes the strong increase in the prices of homes will correct itself through market forces, thus ensuring a soft landing. About 20% of Spain’s GDP comes from the construction industry.

Persistent inflation

The bad news is a persistent inflation differential of between 1 and 1.5 percentage points – inflation was at 3.9% in March – with its EU neighbours. About 70% of Spain’s exports go to the EU.

Jaime Caruana, governor of the Bank of Spain, tells The Banker in an interview (see page 64) that he is concerned with the persistent inflation differential with the rest of the EU countries and the deterioration of the competitiveness of the economy: “In the end, the accumulation of the loss of competitiveness can be seen in the increased difficulty of keeping market share abroad and the ease of imports.” Spain’s current account deficit at 7.3% of GDP is amongst the highest in the developed world.

The country’s membership of the euro means that monetary policy cannot be used to deal with the problem, so the Bank of Spain has been recommending fiscal accommodation and more flexibility, including labour market reform allowing for salaries to be tied to productivity and collective bargaining that is more sensitive to local conditions.

Labour reform

Government, employers and unions agreed a labour reform in May, which took 14 months to negotiate. The search for consensus has delivered a final result that does deal with the abuse of short-term contracts but fails to deliver any sort of labour force flexibility. It is indicative of the government’s lack of momentum in the economic sphere.

Meanwhile, Spain needs to increase the value-added component of its exports (about 40% have a low to medium technological content) and increase competition in such things as commercial distribution and energy. But it looks unlikely that much will be happening on the economic front. “We are suffering from an inertia on reform,” says one economist.

Still, although not ideal, the government can afford to coast on the coat-tails of its predecessor’s reforms and a healthy economy for a while longer. The political front is where the issues are.

The opposition Popular Party (PP) appears incapable of looking towards the future. Instead, it obsesses about losing the March 14, 2004 general elections. The polls had put it ahead but the terrorist attack a few days before and its reaction – blaming ETA and refusing to acknowledge any link with extreme Muslim terrorism and the presence of Spanish troops in Iraq – scuppered its chances. And Mr Aznar has made noises about a comeback.

Caving in

The Catalan autonomy statute passed by parliament is seen as the government caving in to the Catalan allies on whom it is dependent for its majority. It allows Catalonia to proclaim a “national identity” and to retain a larger share of its tax revenues. As one of the wealthiest areas of Spain, it may be an understandable impulse but it augurs ill for southern Spain, namely Andalucía, which is bearing the brunt of the poorest immigrants who arrive by the boatload from northern Africa and are taking their toll on social services. A recent autonomy statute for Andalucía – which has no historical basis, unlike that of Catalonia – is seen as a way of defusing the controversy over the Catalan one, says Spanish newspaper El Mundo, and showing Spaniards that “nothing happens when you define Andalucía as a national reality”.

The PP vehemently disagrees with the government’s attitude to negotiations with ETA. All the more so when the terrorist group’s one-month ceasefire was violated by the destruction of a hardware store while continued extortion letters to businessmen have been found.

Business divisions

On the business front, the saga over the hostile bid by Gas Natural for utility Endesa (see Karina’s Kolumn, page 16) is perceived as the governing party’s attempt to get rid of the current chairman, who was appointed by the PP, and to form a national champion.

(It is seen as a repeat of an aborted operation in 2004, in which construction company Sacyr Vallehermoso took a stake in bank BBVA to, among others things, oust PP-appointed chairman Francisco González.)

The Supreme Court has ruled against the bid, which the Spanish Competition Authority had recommended be annulled on competition grounds, a recommendation that the government chose to ignore. EU authorities are also involved, because German company Eon bid for Endesa and was rebuffed by the government.

Although it is not surprising that the government would like to have the same power of patronage as that held by the PP in its first term, Spain has changed. BBVA and Endesa are no longer entities whose heads can be changed at a whim: foreign investors form too large and important an interest group.

Do these problems matter when the economy is forging ahead? It is worth noting that timidity on the economic front is already being reflected in the growing current account deficit. It is also worth remembering that the Partido Socialista Obrero Español (PSDE) is a minority government. Its boldness on certain fronts – social policy, the Catalan issue, ETA, business matters – provokes as much vehement opposition as support. Politics has an ability to interfere in economics. There is no option but to wait and see.

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