Rajoy closer to seeking bailout

Violent protests in Madrid and growing talk of secession in wealthy Catalonia are piling pressure on Spanish Prime Minister Mariano Rajoy as he moves closer to asking Europe for rescue money.

Rajoy has been resisting calls from influential domestic bankers and the leaders of France and Italy to move quickly to request assistance, but a series of events this week will drive him closer.

With protesters stepping up anti-austerity demonstrations, Rajoy today presents more painful economic reforms and a tough 2013 budget, aiming to persuade eurozone partners and investors that Spain is doing its deficit-cutting homework despite a recession and 25% unemployment.

Fresh data this week suggested Spain will miss its public deficit target of 6.3% of gross domestic product this year, as the central government deficit reached 4.77% at the end of August, already higher than the year-end target.

By front-loading the reforms, Rajoy hopes to sell them to voters as home- grown rather than conditions imposed from outside. Diplomats reported intense last-minute pressure on Madrid, from key eurozone policymakers, to take tougher measures, notably on freezing pensions.

Tomorrow, Moody’s will publish its latest review of Spain’s credit rating, possibly downgrading the country’s debt to junk status.

On the same day, an independent audit of Spain’s banks will reveal how much money Madrid will need from a €100bn aid package that Europe has already approved for the eurozone’s fourth biggest economy.

Spain’s reluctance to seek a sovereign bailout — a condition for European Central Bank intervention to cut the country’s borrowing costs — could propel the eurozone into deeper trouble.

Rajoy moved one step closer to requesting aid, suggesting in an interview with The Wall Street Journal, published yesterday, that he would make the move if debt financing costs remained too high for too long.

“I can assure you 100% that I would ask for this bailout,” he told the newspaper, calling the situation he faces right now “fascinating”.

He also said he had not made his mind up on whether to maintain inflation indexation of pensions, which could cost the state an extra €6bn this year.

“We need to be sufficiently flexible in order not to create any further problems,” he said when asked about pensions.

His comments helped drive the premium investors demand to hold 10-year Spanish debt rather than benchmark German bonds up to 445 basis points, the highest level since early September.

Markets were also reacting to a letter from Germany, Finland and the Netherlands on Tuesday that implied that rescue funds Spain receives for its banks will remain on its public debt. The three said any future direct recapitalisation of banks by the eurozone’s bailout fund should not cover “legacy” problems.

The government’s drive to rein in regional overspending as part of its austerity measures has prompted a flare-up in independence fervour in Catalonia, the wealthy northeastern region that generates one-fifth of Spain’s economic output.

Just as the eurozone crisis has strained relations between wealthier nations of the north and heavily indebted countries to the south, Spain’s crisis has aggravated tensions between the central government and its self-governing regions.

Catalonia is broke and needs a €5bn bailout from the central state to meet debt payments this year, but Catalans are convinced they bear an unfairly large share of the country’s tax burden.

More than half say they want independence from Spain, the highest level ever.

Artur Mas, the conservative president of Catalonia, announced on Tuesday he would hold early elections in November after Rajoy rejected his call for more tax autonomy.

The vote, likely to be presented politically as a referendum for secession, is a challenge to Rajoy, who’s People’s Party has threatened to take central control over the budgets of regions like Catalonia that fail to meet deficit reduction targets.

Catalonia would face a number of constitutional hurdles to secede, and such an outcome is seen as unlikely any time soon.

Analysts say Mas is using growing independence sentiment as a threat to secure more fiscal autonomy.

Anti-austerity groups held fresh demonstrations on Tuesday night in Madrid, a day after police fired rubber bullets at thousands of protesters at the parliament building.

Police arrested 28 protesters on Tuesday and 64 police and demonstrators were injured in the clashes.

The relatively small but intense protests this week have added to Rajoy’s image problems abroad.

Officials in Brussels and Berlin have accused him of failing to sell his reforms effectively, partly due to confusing messages from his treasury and economy ministers and his own office.