How Spain’s Economy is Being Squeezed by the Eurozone Bailout Deal.

In attempts to ease its mushrooming financial pains, Spain unveiled new austerity measures that aim to reduce 65 billion euros from the public deficit by 2014.

The move is part of an agreement Spain’s Prime Minister Mariano Rajoy made when he accepted a Eurozone bailout for his country’s ailing banking system. Rajoy surrendered to mounting pressure to at least make an effort to avoid a full state bailout.

‘We have very little room to choose. I pledged to cut taxes and now I’m raising them. But the circumstances have changed and I have to accept them,’ Rajoy told the national parliament.

As protests erupted from anti-austerity crowds that gathered in Madrid, Rajoy explained plans to roll back social welfare protections and immediately raise taxes so that he could secure emergency aid and placate jittery investors.

Rajoy announced higher taxes and cuts to unemployment benefits, union pay, and civil service perks.

Amid boos and heckling, Rajoy told the parliament, ‘These measures are not pleasant, but they are necessary. Our public spending exceeds our income by tens of billion euros.’

The moves highlight how Rajoy and Spain are at the mercy of the EU’s tough bailout provisions if the government hopes to get any more money for its struggling banks.

Spain Playing By the Eurozone Bailout Rules The measures outlined Wednesday constitute the fourth austerity plan from Rajoy during his seven months in office. They’re part of provisions associated with the Spanish economy’s 100 billion euro bailoutpackage.

European leaders maintained the possibility of purchasing Spanish debt to bring down elevated yields as long as Rajoy abides by their demands. Over the past few months, Spain’s borrowing costs have skyrocketed. The yield on the 10-year Spanish government bond eclipsed the 7% level, which is widely viewed as unsustainable.

Following Rajoy’s announcement, the yield inched down to 6.81%.

Struggling Spain and its need for foreign capital to maintain public services and keep its banks from failing has left its government with little control over policies and at the mercy of markets.

Analysts noted that Rajoy has already been forced to rescind some of his campaign promises, putting Madrid under “de facto” supervision from Brussels.

Any Hope for Spain’s Economy? Beleaguered by five years of economic stagnation and recession, Spain’s unemployment rate has swelled to a staggering 24.4%. With tax revenue falling and the country’s deficit rising, banks are seriously struggling just to stay afloat.

Worries have spread that Spain’s economy may become the next Greece, Portugal, or Ireland and will need a full-blown sovereign bailout.

There is also a growing unease that Italy’s economy may be the next country to hold its hand out, making all the PIIGS recipients of a Eurozone bailout package.

Yet, the EU plods on. In Brussels Wednesday, the European Commission applauded Spain’s new fiscal program, calling it an important step.

On Tuesday, EU finance ministers agreed to allot Spain’s economy an extra year, until 2014, to bring the public deficit down to 3% of gross domestic product (GDP) and eased this year’s target of 6.3%, acknowledging that even the relaxed target is a stretch.

Eurozone Debt Crisis: “Stability” on the Way In the midst of all this economic turmoil are the increasing questions surrounding Europe’s latest tool to stabilize the euro currency union.

The European Stability Mechanism (ESM), a permanent bailout fund with a maximum lending capacity of 650 billion euros, is designed to replace the European Financial Stability Facility (EFSF) that backedbailouts for Greece, Portugal and Ireland.

The ESM was supposed to be up and running Monday, but it has not yet been ratified by all 17 euro governments.

Announced in June, the ESM was created to break the “vicious circle” between banks and government, which has threatened to bring down the Spanish economy, the region’s fourth-largest economy. At issue is just how much power the ESM will have, if it will be effective, and if it will have enough money to accomplish some of its far-reaching goals.

That’s a lot of “ifs” at a crucial time when decisiveness is needed.

Since the ESM does not yet exist, Spain’s loans will be the responsibility of the banking sector, not the government. But before the ESM is approved other nations may want the Spanish government to guarantee the bailout loans.

‘The credibility of the rescue package for Spain has been called into question even before the loans have been disbursed,’ Nicholas Spiro, director of London-based Spiro Sovereign Strategy, told CNN Money. Spiro added that even with its full firepower, the ESM is ‘woefully inadequate.’

Already, the ESM is sounding unstable – meaning bigger Eurozone bailout packages are likely on the way.

Diane Alter

Contributing Writer, Money Morning.

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