Bloomberg News

Spain in ‘Danger Zone’ as Europe Debt Crisis Persists, IMF Says

July 29, 2011

(See EXT4 for more on Europe’s sovereign debt crisis.)

July 30 (Bloomberg) -- Spain is still in “the danger zone” and must keep up momentum in restructuring its economy to stave off contagion from Europe’s sovereign-debt crisis, the International Monetary Fund said.

“The outlook is difficult and the risks elevated,” the Washington-based IMF said in a report yesterday after a visit by staff to Spain. “The policy agenda remains challenging and urgent -- there can be no let up in the reform momentum.”

The assessment coincided with Prime Minister Jose Luis Rodriguez Zapatero’s decision the same day to call early elections on Nov. 20 and Moody’s Investors Service’s warning that it may downgrade Spain. The euro-region’s fourth-biggest economy is trying to rein in surging borrowing costs that have pushed the yield on its 10-year bond above 6 percent, hindering efforts to stoke growth as unemployment stays above 20 percent.

“Many of the imbalances and structural weaknesses accumulated during the boom remain to be fully addressed,” the fund said. “Spain is not out of the danger zone” and “scenarios of negative spillovers from Spain indicate a substantial impact on the rest of Europe and indeed globally, given the country’s systemic importance.”

The report, a so-called article IV assessment, praised Spain for its “strong and wide-ranging” response to economic challenges in the last year. The country met its 2010 budget deficit target, forged ahead with efforts to curb the cost of its pension system and reshaped its banking industry by forcing lenders to meet minimum capital requirements, the IMF said.

‘Potentially Severe’

Spain still needs to do more, the fund said. “Downside risks dominate” the outlook for economic growth in the near term because of rising concerns about sovereign risks in the euro area, according to the report.

“Risks are tilted to the downside and potentially severe,” the fund said.

The IMF said Spanish banks that need capital should raise it “promptly from the market” to help allay concerns about the health of the financial system. The Bank of Spain, which said in March that 12 lenders would need to raise 15 billion euros ($22 billion) to meet new capital requirements, said this month the process of recapitalizing the system is now almost complete.

“In light of the uncertain operating environment and comparing with other jurisdictions, staff sees merit in further building capital, liquidity and provisioning buffers in the system over time,” the fund said.

Labor Laws

The IMF said that in terms of Spain’s efforts to cut its budget deficit, the “larger risk” to the 2011 target is that some regional governments may not keep to spending limits.

“All levels of government should deliver on their commitments,” the report said. “Bold strengthening” of changes to labor laws are also needed to reduce the scope of collective bargaining and the practice of indexing wages to inflation, while severance payments should be cut to at least average European Union levels, the IMF said.

Meanwhile, Spain should make an early commitment to balancing its books over the medium-term, while meeting medium- term fiscal requirements “will likely require further action,” the IMF said.

The fund’s staff predict the deficit will narrow to 4 percent of gross domestic product by 2014. Taking into account the risk of a potentially weaker outlook and the possibility that the regions will miss their targets, additional measures of about 2 percent of GDP would be needed to reach the government’s goals, the IMF said.

In its report, the fund maintained its predictions for Spain’s economic growth, forecasting expansion of 0.8 percent in 2011 and 1.6 percent next year.

--Editors: Craig Stirling, Fergal O’Brien

To contact the reporter on this story: Charles Penty in Madrid at cpenty@bloomberg.net

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


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