MercoPress. South Atlantic News Agency

Spanish Central bank warns about bulging budget deficit and unemployment

Governor Miguel Angel Fernandez-Ordoñez linked some banks soundness to consequences of high unemployment

Controversy sparked between Spain’s government and the governor of the Central Bank over the magnitude of the budget deficit and rising unemployment which threatens loans and consumers’ repayments plus the stability of some Spanish banks.

“In the absence of corrective measures, the deterioration of the fiscal position will continue making the adoption of a credible strategy of budget consolidation essential in the medium term”, Governor Miguel Angel Fernandez Ordoñez told parliament.

“If it is not, rising public debt and its influence on the cost of financing the economy, and even the solidity of the financial system and its capacity to channel resources, could become a very heavy weight on the possibility of recovery”.

The Spanish public deficit would be close to 10% of GDP in 2009, Fernández-Ordoñez said, adding the government's 2010 budget proposal, currently under debate in parliament, is a step toward bringing the deficit down.

“The important thing is to realize that the deficit has an important structural component because spending has grown at high rates while extraordinary revenue linked to the [recent] housing boom has been lost forever” Fernandez-Ordoñez warned.

The Socialist government has said it is committed to bringing the deficit back to within European-Union recommended levels of 3% of GDP by 2012, though many economists are skeptical.

The central bank chief also talked about the Spanish unemployment rate, which is more than double the European average and is expected to remain above 20% for several years to come.

“The deterioration of labor market and the rise in unemployment are the most serious problems faced by the Spanish economy and the recovery of fiscal consolidation”, said Fernandez-Ordoñez insisting that reforms must reduce the high ratio of temporary workers -- around 90% of those laid off over the last year held temporary contracts -- and permit more flexible wage negotiations.

“All of this would help to soften the impact of the crisis on employment, reassign excess workers toward more productive sectors and raise the potential growth of the economy”, he added.

His remarks on unemployment did not please the administration of President Rodriguez Zapatero who said he should keep to the specific monetary issues of the bank.

However Fernandez-Ordoñez revealed that each half point increase in unemployment means a rise in delinquency rates which have a direct impact on the health of the banking system, and “this refers to the short term” not the long term.

However he said that the 2010 budget proposal, the first within a strategy of consolidation, confirms “a commitment in line with the necessity to provide some credibility to the process”.

If the government faces problems meeting the levels, it must continue to convince markets of its willingness to do so, the central banker said.

Fernandez-Ordoñez said the government's proposal to raise value added tax by 2 percentage points in 2010 was the least painful of all the options available for the economy.

“The VAT and indirect taxes are the least damaging because they are the taxes that least hit incentives to invest, save and work”, he said. The plan to raise VAT has faced sharp criticism as a tax on Spain's middle and working classes.

Nevertheless Spain's economy will likely recover later than others in Europe and could suffer a prolonged slump unless these ambitious reforms are addressed said the governor of the Spanish central bank who is also a member of the European Central Bank's governing council.