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Rajoy U-turns, stalls and plays chicken

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J. Luis Martín.- 09/15/2012

“[The prime minister] is mistrusted because he is unpredictable. This is partly because of his inconsistent messages, his erratic policies, and because he refuses to adopt a concrete economic strategy that is understandable and stable,” Spain's Prime Minister Mariano Rajoy said about his predecessor, the Socialist Prime Minister, José Luis Rodríguez Zapatero, in November 2010.

Only two years have elapsed since he addressed these harsh words and it is almost perverse that such words are so fitting of Rajoy’s current self. And this, as Rajoy also said of Zapatero, is dangerous.

Spain’s political arena: nothing new

Spaniards watch with dismay at how the roles at the culprit of their country’s political system have simply been reversed. The conservative leader, who once claimed to have the will, competence and strategy to resolve the crisis, as well as to return credibility to Europe’s fourth-largest economy, is now being chastised at home and abroad for his whimsical leadership. On the other side of the aisle, Socialists accuse Rajoy’s government of ruining the country, but are yet to offer concrete ideas and proposals themselves. In fact, much like the Conservatives did before last year’s general elections, Socialists are waiting to reap the political fruits heightened economic and social depression may bear.

Rajoy flip-flops…

The Spanish prime minister not only betrayed his fellow citizens by doing a complete U-turn on his electoral program within days of being elected, but he now seems to be doing the same to his European partners.

For months, locking the European Central Bank into guaranteeing Spain’s financing needs has been Rajoy’s fundamental demand and objective. In essence, the premise he embraced from the start of his race to the Moncloa palace, the government headquarter, was: keep liquidity flowing and I’ll fix Spain.

As the turbulences in the Eurozone become stronger, and as euro economies dangerously deteriorate, Germany has finally folded to the ECB’s debt-monetization intervention via its long-expected “bazooka”: the “Outright Monetary Transactions” (OMTs). The “plan” today is merely an attempt to buy time for politicians and European institutions to regain control of the situation and save the common currency from breaking apart. And this is exactly what Rajoy wanted.

However, it is under such a scenario that the Spanish prime minister now seems to be making yet another U-turn, for he is now pulling the breaks on the program he so adamantly pursued in the first place.

… and stalls

To the surprise of many, Rajoy told the Spanish parliament on Wednesday that he does not know if Spain needs to ask for a bailout.

Some argue that Rajoy is perhaps hoping that the mere threat of the ECB’s use of its freshly acquired gunpowder will keep market tensions at bay for Spain. Others point at the Spanish government’s reluctance to endure the “humiliation” and political fallout that the bailout’s required conditionality would entail. Both arguments are infantile, however. Markets may have proven complacent in recent weeks, but they are surely not going to let “talk” do the work for the euro. Moreover, it is quite clear that ECB President Mario Draghi’s OMT program via an “Enhanced Conditions Credit Line” (ECCL), the newest eurocrat term for “light bailout,” was specifically scripted to help Spain save face.

Testing the patience of markets and European partners

Market participants seem bewildered about Rajoy’s flip-flop and stalling strategies. Goldman Sachs’ take on the matter encapsulates the problem well: “The opposition seen in Germany in response to Mr Draghi’s preparedness to buy sovereign debt implies that current posturing in Spain will not wear well with the politics of signing a Memorandum of Understanding in Germany.”

Peter Tchir, a credit expert, investor and frequent guest at Bloomberg TV, has warned: “Under no circumstances will Spanish yields remain low for long if Spain does not embrace a plan.”

Tchir has also reflected on Rajoy’s character by saying that the premier’s mood “seems to swing with the Spanish bond market.”

Rajoy is also testing his European partners’ patience.

The French are said to be exerting pressure on Spain to request the bailout. After all, it is not only Rajoy’s credibility that is being eroded by the hour, but also the alleged infallibility of the ECB’s latest and most daring move thus far in the crisis. Time is running out.

However, Rajoy has exasperated both markets and European partners before.

The Spanish premier first publicly flexed his muscles last March, when he decided to ignore the EU-accorded Spanish deficit target of 4.4 percent of gross domestic product for this year, and, unbeknown to his European partners at the time, announced his own target of 5.8 percent. This episode took place at the same time Rajoy delayed disclosure of the national annual budget until after the Andalusia region elections (which his party lost later that month). His image as an arrogant and potentially reckless politician was duly noted worldwide.

The “Spain is not Uganda” negotiations leading to last June’s €100bn banking sector emergency loan from Brussels - which Rajoy said came through because he had “pressured Europe” - was another dire spectacle of the prime minister’s less than sensitive approach to the Eurozone’s high-wire diplomacy. At the time, it was leaked that Spain’s Economy Minister Luis de Guindos allegedly threatened his European partners: “If you want to force our bailout get ready to spend €500bn. And €700bn more for Italy, next in line.” (An interesting detail as we now learn reports about a €300bn 'troika' bailout for Spain in the works).

Next month will see regional elections take place again in Spain, as Basques and Galicians go to the polls on October 21. Given Rajoy’s track-record, if Spain finally requests a bailout it will most likely do so after such regional elections have passed.

Rajoy plays “chicken”

A few layers under Goldman Sachs’ analysis on Spain’s “posturing” rest Germany’s biggest fear: moral hazard. Should Spain get bailed out, Rajoy may no longer feel pressured to act, leaving the ECB, and Germany, in a tough situation. While Draghi has tried to sound convincing about pressing the “stop” button on the presses for countries not adhering to the program’s “conditionality,” it is hard to imagine that the central bank would let Spain fall and cause the euro to unravel. Rajoy seems to be aware of this and is willing to play chicken.

During a televised interview last week, Rajoy explicitly said: “About the subject of the bailout, here is an important thing: if we request it, they can give it to us. This is very important… the ECB has said that the euro is irreversible.” He also added: “yields have fallen considerably, so we can finance ourselves better.”

Last December, just as Rajoy took office, I asked Economics Nobel Laureate Vernon Smith about Spain’s dire situation and the need to adopt austerity policies and structural reforms. His answer then has become quite descriptive of the current situation:

“[M]y view is that if Spain is bailed out that [austerity] policy runs the risk that it will just kick the can down the road, and could easily end up making it far worse for you than if you bite the bullet now. The lasting lesson for the future is for Spain not to paint itself into this corner in the first place. The open question is whether the Spanish political process can credibly put its house in order if they are being protected from default. That is an umbrella fraught with incentive leaks and hence may not even be in Spain’s interest.”

Ultimately, as Tchir warns, less complacent markets will probably force Rajoy to request the bailout sooner than later, only precious time will have been wasted and, quite possibly, “conditionality” may not be so “light.”

Rajoy seems to have adopted the same shortcomings he criticized of Zapatero two years ago: he is being inconsistent, erratic, and unpredictable. Only Rajoy is more arrogant, which makes him even more dangerous than his predecessor.

The prime minister recently said that he believes that the future will be brighter for Spain and that he will be re-elected in 2015. Perhaps Rajoy should take a look at his other words to Zapatero two years ago and reflect harder on his future and that of his country: “Understandably, once again, you try to seek refuge in a golden future, even if it is made of glitter... What else can you do?"

J. Luis Martín is director of Truman Factor.

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