WSJ: Europe Debt Concerns Grow

EUROPE NEWS|MAY 23, 2011, 2:22 P.M. ET
Europe Debt Concerns Grow
Spanish Vote Results, Greek Woes, Ratings Warnings Add to Fears

By JONATHAN HOUSE And DAVID ROMÁN

MADRID—Concerns mounted about Europe's debt problems following a crushing defeat for Spain's ruling party in weekend elections, compounded by infighting in Europe over whether Greek government bonds should be restructured and new warnings from credit-rating agencies.

The euro fell sharply, slipping below $1.40 for a while Monday, its lowest level in two months, and European stocks and bond prices moved lower. Government-bond prices continued their declines of last week, adding to anxiety by making it more expensive for governments to fund themselves. Spain's 10-year government bonds now yield more than 5.5%.

The heavier-than-expected losses for Spanish Prime Minister José Luis Rodríguez Zapatero's Socialist Party raise questions about his government's ability to pursue plans to overhaul the euro zone's fourth-largest economy and thereby ward off an international bailout.

Following Sunday's vote in 13 out of Spain's 17 regions, the Socialists could lose as many as six of the seven regional governments they controlled to the opposition Popular Party, led by Mariano Rajoy.

As part of a backlash sparked by a deep economic crisis and 21% unemployment, the Socialists polled around 10 percentage points lower than Mr. Rajoy's party in municipalities across Spain. The Popular Party was, on average, one point ahead in the 2007 elections.

Anxieties about Europe's debt problems have been fanned further by a dispute between the European Central Bank and euro-zone governments about what to do about Greece's large and growing debt burden.

Euro-zone governments are increasingly coming to the conclusion that Greece should seek to postpone repayments on its bonds coming due in 2012 and 2013. ECB officials have responded by warning that any bond restructuring would make the bonds ineligible as collateral at the ECB, a move that would cut off an essential financial lifeline for Greek banks.

The Greek government said Monday its cabinet had agreed to cut a further €6 billion ($8.5 billion) from its budget this year to meet its deficit target. It also said it would "immediately proceed" with the sale of stakes in telecommunications company OTE, Hellenic Postbank, the Athens and Thessaloniki ports and the Thessaloniki water company. The cabinet also agreed to create a sovereign-wealth fund composed of privatization and real-estate assets.

Furthermore, ratings agency Standard & Poor's Corp. lowered its outlook on Italy's $1.9 trillion of government bonds to negative, citing weak growth prospects and a slipping economic-reform agenda. Italy, which accounts for nearly 20% of all government debt in the European Union, is rated single-A-plus. This followed Fitch Ratings' Friday downgrade of Greek debt by three notches, to single-B-plus.

Meanwhile, Fitch on Monday lowered Belgium's rating outlook to negative from stable and affirmed its long-term foreign and local currency ratings at double-A-plus.

Adding to the mix was a new signal of euro-zone economic weakness. A survey by financial-information firm Markit showed that output growth of euro-zone manufacturing and services industries slowed to its slowest pace in seven months in May. Even economic powerhouse Germany showed signs of fatigue.

Analysts said the Spanish election results raised questions about government austerity plans.

"The dismal election results for the ruling Socialists will hamper the government's ability to reinforce its deficit-reduction plan," said Raj Badiani, an economist at IHS Global Insight in London. Madrid is seeking to reduce its budget deficit to 6% of gross domestic product in 2011 and to 3% by 2013, from 9.3% in 2010.

The opposition was quick to reiterate its view that Mr. Zapatero should call national elections ahead of the March 2012 deadline.

"Yesterday, it wasn't us who called for an early general election, it was the Spanish people," Popular Party spokeswoman Ana Mato said in a television interview. Several Spanish newspapers, including ABC and El Mundo, echoed the call for early elections in their editorial pages.

Mr. Zapatero, whose party lacks a parliamentary majority, late Sunday said he didn't plan to call early elections. He said his government's priority remains carrying out economic overhauls, so long as it has the necessary parliamentary support.

Bank of Spain Governor Miguel Angel Fernández Ordóñez said Monday that the government must push forward with overhauls to lower borrowing costs.

Key to bolstering investor confidence, Mr. Fernández Ordóñez said, is meeting deficit-reduction targets, cleaning up the country's unlisted savings banks and overhauling labor laws to encouraging hiring.

Dealing with the budget deficit may be even tougher after the elections. Regional and municipal governments control about half of spending and have made little progress in cutting costs.

"It is to be expected that some of the new governments may deem the deficit target for the regions of 1.3% of GDP as overly ambitious," said Antonio Pascual, economist at Barclays Capital in London, in reference to central government's 2011 target.

Some local economists and business leaders have forecast that changes in government could lead to the discovery of hidden piles of debt, as happened in Catalonia. After Catalan nationalists dislodged a Socialist government in the wealthy northeastern region in November, incoming officials said the local budget deficit was twice as big as previously thought.

Write to Jonathan House at jonathan.house@dowjones.com

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