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Study of Spain Global Crisis and Austeriity Measure

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  • 1. Study of Global Crisis in Spain and the Recovery Measure In Completion of Individual Assignment for Monetary & Fiscal Policy Course – 2011Submitted by:Erick Prajogo – GNOV10IT047
  • 2. Not until the financial crisis hits the EU countries, Spain is touted as one of the EU countrieswith dynamic economy, fueled by strong growth in real estate (EuroChallenge, 2011). A lotof people from wealthier European countries, such as Germany and United Kingdom, weremaking big business in the real estate field. Not only that, foreign investment are alsoflowing in automotive and tourism industry (Economy Watch, n.d.). The tax break given bythe Spain government makes it more attractive for other European countries to invest inSpain. The economy of Spain on 2006 has been considered as similar to Germany.When Spain adopted Euro as its currency in 1999, it brought a low interest rate, which leadsto attractive loan for housing and consumerism. This situation keeps on going for few yearsand the government did not do much when it comes to fiscal policy. Because of budgetsurplus due to prosperous economy, government keeps spending to build the country. All ofthis comes to an end when financial crisis hits US on 2008. It is still an argument whetherSpain went because of crisis in US or not. But the fact was credit is contracting all over theworld during that time.The first occurrence of the crisis happened in 2007, when it first hit the real estate market.So by 2007, crisis already occurred, on which the credit crisis in US sealed the deal. Year2007 was opened by a decrease of 10% in real estate market, because people were suddenlystop purchasing properties (GEAB, 2007). The situation even got worse in 2008, crunchingthe real estate sector in Spain as it reverse everywhere across Europe. The immediate effect
  • 3. is felt by the construction workers and housing agencies, that leads to increase inunemployment as much 8.7% in 2007 (News Spain, 2008). They were not particularlyworried at that time because they still have surplus from the past. But what they did notknow that time was that situation will only get worse.With the economy crumbling as of 2009, unemployment has risen to a very high level,nearing the depression level. In 2010, almost 20% of Spanish people are unemployed(Wachtel, 2010). With that amount of unemployment, you can harness the effect to theeconomy, as unemployed people means that they can’t pay taxes. If there are no taxes,there is no income to the government. Most of these unemployment’s are youth, whodropped out from school because of the big boom in construction field (Poggioli, 2011).These youth, because they dropped out from school, will not have the proper intellectualcompetence to find a job other than construction. While some of the European countriessuch as Germany, UK, and The Netherlands were capitalizing on knowledge, Spain clearlylacks behind in this area, which leads Spain to lose its competitiveness.The Spanish government, having seen the high unemployment number, started to think away to rectify the situation. The first action that came was raising 41 billion in 2008 to helpbanks by buying the toxic asset (Lee and Bond, 2008). Though, most of the economists haveexpressed their worry that this financial aid will not help to recover the economy. Thesituation behind the screen is already so bad that one of the biggest land developers inSpain, Martinsa – Fadesa, went bankrupt. And this is later followed by chain of bankruptcy ofother land developers. To protect the real estate industry from further collapse, Spanishgovernment made a huge investment in infrastructure project, with the amount of 19 billioneuro (Property Showroom, 2008). Spanish also put in effect a program to stimulate theautomotive industry, following example of Germany, by using scrappage scheme. Withscrappage scheme, the Spanish people can trade in their old car, for an amount of subsidy,to buy a new car with less gas emission. This scrappage scheme is implemented everywherein Europe to save the automotive industry from rampant crisis which have hit US automotivecity, Detroit, so bad (Advoco, n.d.).
  • 4. When the financial aid to Spanish bank seems like a blessing came from heaven, it wasactually writing a huge debt on the balance of Spanish government. In order to embark on itsrescue plan, Spanish governments are selling sovereign bonds. With so many debts thatSpain has, in tandem with the slow growth rate of only 0.1% in 2009, the confidence ofinvestors on Spain are declining. In 2009, the credit rating of Spain has been downgradedfrom AA+ to AAA (Kollmeyer, 2009). There were also a huge bias in the market that Spainwill be the most likely to default, after Greece. The story of Greece that gone default hasprofound effect on the interest rate of Spain on that time. People have seen that this canhappen in one country in euro-zone, so people began to speculate that this can happen inSpain and Portugal.This in turn made investors worry about investing in Spain. To gain the interest from investorto lend money to Spain, the government has to raise the interest rate. With the increase ofinterest rate, lending money becoming very expensive for Spanish government. Spain is in
  • 5. dilemma here, because without borrowing, it cannot spend. Even if they borrowing, butbecause of high interest rate, they will have to spend a lot of money only to pay the interest.The chart below depicts the rise of interest rate in Spain in 2010.Although situation is very bad, the situation in Spain is still better compared to Greece. ElenaSalgado, Spain Finance Minister, claims that bailout from the European Central Bank is notnecessary for Spain (Brett, 2010). Even, Spain should not take a bailout, because it alwaysfollowed by extreme cut on budget spending, which might send the Spain economy todeflation spiral. Spain has started restructuring effort on 2009, following the governmentintervention in revving up the economy in 2008.In 2009, austerity measure has been taken to cut the budget deficit of 11% of GDP. The firstausterity endeavor taken by the government is to increase the tax of the higher incomepeople. This effort is followed by budget cut in various front including government spendingin public workers, cut of salary as much as 5% in 2010, and freezing of state-pension in 2011
  • 6. (Legorano, 2010). This austerity measure caused a huge outcry from the Spanish population.But if this is not done, European Central Bank would not be willing to help Spain by buyingtheir sovereign bond. All of these efforts are done to reduce the budget deficit of Spain,which increased dramatically because of big spending in 2008, as shown in the graph below.Perhaps one of the extreme measures is the labor reform, where not only the salary is beingcut up to 5%, but also changes of policies are being implemented. Government made theprocess of firing an employee cheaper in Spain, which is otherwise very high, and makescompany reluctant to take new employee. The government is hoping that this policy willagain make company interested to hire new employees. From the perspective of employees,they were thinking otherwise, and afraid that this reform will only cause more people to befired. All of this is done in order to recover the unemployment rate of 20% (BBC News,2010).To further cut the budget deficit, Spain will increase tax on cigarette and invest on cleanenergy plan that will generate revenue for coming years. To curb entrepreneurship withinthe country, which was rather decline in the past years, the government makes it easier andcheaper for individual to start a company, and provides benefit on it (Mallet, 2010).
  • 7. To increase investor’s confidence on Spanish bank, the government increases the capitalrequirement of Spanish bank from to 8%. With the increase of capital, government wants tomake sure that the bank will be more solvent (News from Spain, 2011). The focus being onthe saving bank is because these banks have lent heavily in construction sector, up to 40%,which have been hit very hard during the real estate meltdown in 2008. The characteristicsof these saving banks are that they are small and spread everywhere. Overall in Spain, thereare around 45 saving banks, which were forced by the government to merge. The merger ofsaving bank has brought the number down to 18 banks. Banks that do not have enoughcapital will be helped by the government, in exchange with part-nationalization scheme.Having seen all the measures taken by the Spanish government, will they recover thefinancial crisis? Spain might be in track of recovery, but it will not be speedy recovery. Spainhas to be careful with every step that it will take in the future, as recession still looming, andunemployment are still at 20% level. Spain can be relieved about its flourishing tourismsector, which contributes to around 10% of the GDP. (PageRank Studio, 2010)Because of the economy recession, everything tends to be cheap in Spain, and many peoplefrom other countries are more interested to visit Spain. Saving banks across Spain is alsomerged, and the government is helping them by buying their bonds, in exchange fornationalization and tighter banking policy. This will bring order to saving banks from a ratherpolitically deformed structure in the past. Other good sign is that the housing market hasbegun to see a recovery, although still very slow. One thing that Spain should do is toeliminate the public view of Spain will default, similar to Greece. Spain in any way cannot becompared to either Greece or Spain. Somehow, if the government can increase theconfidence of investor, by reducing the budget deficit to 6% on 2011, the future will lookbrighter for the economy of Spain.
  • 8. BibliographyAdvoco Spain Scrappage Scheme, [Online], Available: http://www.advoco.es/home/22-latest/34-spain-scrappage-scheme-plan-2000e.html.BBC News (2010), 2 June, [Online], Available: http://www.bbc.co.uk/news/10220984.Brett (2010) An Updated Look at Europe’s Sovereign Debt Woes, 3 December, [Online],Available: http://contraryinvesting.com/sovereign-debt-trouble/europe/an-updated-look-at-europes-sovereign-debt-woes/.Economy Watch Spain Industry Sector, [Online], Available:http://www.economywatch.com/world_economy/spain/industry-sector-industries.html.EuroChallenge (2011) An Overview of Spain Economy, [Online], Available: http://www.euro-challenge.org/doc/Spain.pdf.GEAB (2007) Burst of Europes Real Estate Buble, 16 January, [Online], Available:http://www.leap2020.eu/Burst-of-Europe-s-real-estate-bubble-Spain-comes-first-soon-followed-by-France-and-UK-an-average-of-10-in-2007_a592.html.Kollmeyer, B. (2009) SP Cuts Spains Credit Rating, 19 January, [Online], Available:http://www.marketwatch.com/story/sp-cuts-spains-credit-rating.Lee, K. and Bond, P. (2008), 20 October, [Online], Available:http://www.wsws.org/articles/2008/oct2008/spai-o20.shtml.Legorano, G. (2010) Spain to freeze state pensions in 2011, 12 May, [Online], Available:http://www.globalpensions.com/global-pensions/news/1636141/spain-freeze-pensions-2011.Mallet, V. (2010) Spain seeks to impress with austerity, 3 Deember, [Online], Available:http://www.ft.com/cms/s/0/32c60f34-fee8-11df-ae87-00144feab49a.html#axzz1KyfsRd2Y.News from Spain (2011), 25 January, [Online], Available: http://news-spain.euroresidentes.com/2011/01/reform-of-spanish-savings-banks.html.News Spain (2008) Unemployment rises in Spain, 25 January, [Online], Available:http://news-spain.euroresidentes.com/2008/01/unemployment-rises-in-spain.html.PageRank Studio (2010), 2 March, [Online], Available:http://pagerankstudio.com/miscellaneous/article_2838.htm.Poggioli, S. (2011) Spains Boom To Bust Illustrates Euro Dilemma, 27 April, [Online],Available: http://www.npr.org/templates/story/story.php?storyId=128514195.Property Showroom (2008) Spain unveils extensive infrastructure investment, 17 December,[Online], Available: http://www.propertyshowrooms.com/spain/property/news/spain-unveils-extensive-infrastructure-investment_112121.html.Wachtel, C. (2010) Spain, The Next EU Sovereign Debt Crisis, 24 June, [Online], Available:http://seekingalpha.com/article/211595-spain-the-next-eu-sovereign-debt-crisis-coming-soon.