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Rajoy, Spain's new PM, warns of tough economic road ahead

Spain's new prime minister Mariano Rajoy was sworn in today amid muted optimism that he can make the tough economic reforms that the eurozone wants.

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But during the two-day debate on his appointment that started Monday, Rajoy did not paint an optimistic short-term future. Instead, he pleaded for Spaniards' patience. 

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Spain is largely believed to have reentered a recession this quarter, and its economy is expected to contract between 1 and 1.5 percent in 2012. The unemployment rate, already the European Union’s highest, is expected to continue growing from its current rate of nearly 22 percent.

Rajoy left out the details of his plans, especially in terms of labor and financial sector reforms. But by the end of the year, his government will pass emergency decrees to tackle the economic challenge, he said in his speech before parliament.

Rajoy said at least €16.5 billion would be cut in 2012 to meet Spain's commitments, but that is may be an overly optimistic target. By the end of 2011, Spain was supposed to cut its public deficit to equal 6 percent of gross domestic product, and even further in 2012 to reach 4.4 percent of GDP. But this year's deficit will be higher than expected because of the toll the debt crisis took on Spain's public finances. 

Regardless of what is required, Rajoy has said Spain will meet its target by 2012 – a tough commitment, given EU Commission estimates that its 2011 deficit spending will reach 6.3 percent and it is on track for reaching 5.3 percent in 2012. That implies severe pain.

Some analysts expects spending cuts to at least triple from 2011’s €11.4 billion. Rajoy has been clear that he intends to continue his predecessor's track record of cuts and economic reforms, in line with German and French guidelines, and Germany was quick to ask Rajoy to speed up reforms after the parliamentary rubber stamp Tuesday on his new post. The only spending increase will be for retirement payments.

Mandate to cut

Rajoy's conservative majority  voted the new prime minister in for four years, but the left and nationalist parties – who make up almost half of the parliament – voted against him or abstained. The stark vote breakdown is likely to be repeated in the legislative agenda in coming months because Rajoy’s Popular Party doesn’t need further legislative support to pass any vote. It received almost 45 percent of the vote

Furthermore, if the election results are any indication, Spaniards are willing to take the austerity measures they know are coming. Rajoy therefore has ample space to maneuver. In the end, that is Spain’s biggest asset.

The concern is not about the country's dedication to making cuts, but whether much-needed growth can happen at the same time. If it doesn't, Rajoy could face waning support for his economic agenda.

“The concern is on the activity side – that is, whether the economy will grow enough to garner support for Rajoy’s strategy,” says Speranza, the London-based economist. “The cost in terms of economic activity of austerity is significant. It makes it more difficult to implement reforms.”

So far, things are on track. “It was quite impressive. Even before elections, both main parties began to commit themselves to an austerity agenda,” says Stewart Fleming, associate fellow in international economics at Chatham House, a British think tank. “They didn’t use the crisis as political football and markets have responded positively.” 

But there is always the risk of backsliding, analysts warn – particularly because Spain is tied to other countries struggling to return to growth. “Reform by individual members is made more difficult because Europe as a group has yet to come to terms with satisfying financial markets,” Fleming says. 

The world is just going to have to accept the solution comes with time. “Markets look at tomorrow, but this will take years,” Speranza says.


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