Faced with the highest unemployment in the developed world and an economy skidding into a double dip recession, Spain is about to embark on a series of Reagan-style financial and labor market reforms whose success could affect the future of the entire euro project.
Economy Minister Luis de Guindos told Fortune in an interview that the reform package would include two sweeping changes to the country's stringent labor rules with the goal of making it easier for companies to hire and fire staff and pay them according to their needs rather than meeting national regulations.
The other major initiative will be aimed at reducing the number of the country's problem banks by demanding that all institutions take hefty markdowns on their problem real estate loans.
A former Lehman Brothers banker in Spain, de Guindos estimated the total write-downs at 50 billion euros ($65 billion). The second leg of the reform is to encourage mergers between weak banks by offering them an extra year longer until they have make the markdowns for problem real estate loans and giving them loans from the government's bank bailout fund to accomplish the merger.
According to an official who asked not to be quoted by name, because the banks will receive capital injections as loans – in the form of purchases of preferred shares by the government's Fund for the Orderly Restructuring of the Banks – the government is maintaining that it is providing no public bank bailout funds. It's perhaps being mindful of the backlash caused by the TARP program in the U.S., which required $700 billion in taxpayer money.
De Guindos indicated that the government may ask the European Union to relax its demands that the Spanish budget deficit be reduced from 8% of GDP last year to 4.4% this year. That would require budget cuts of $51 billion, which could wreak havoc in a nation in the midst of a recession. "This is something we'll have to analyze in detail with the European commission and we'll decide what is the ideal path and direction of the deficit," de Guindos said. "It is not closed. We have agreed to 4.4% but it may be adjusted."
The government reported last week that the Spanish economy shrank by 0.3% in the fourth quarter of 2011. The International Monetary Fund forecasts negative growth of 1.5% for the year in 2012. This has led some economists to predict dire consequences for the country if an amount equivalent to 4% of GDP is cut from the government budget in one year. It would largely require the government to lay off thousands of employees.
The new government has already been forced to deal with one nasty surprise: last year's deficit was supposed to be 6.6% of GDP. But on Dec. 26, it found out that the previous socialist government had run up an 8% deficit despite promises to the contrary to European authorities. As a result, the government of Prime Minister Mariano Rajoy stunned the country – and its conservative backers – by sharply raising taxes, especially on the wealthy, something that it had explicitly promised not to do.
The most contentious reforms will affect Spain's labor market, which is the most rigid in Europe. The government learned this week that unemployment hit a peak of 23% in the fourth quarter, and even more worrying, 45% for those under 25.
