August 9, 2012 / 11:03 AM / in 5 years

Clouds gather over Spain's Rajoy as EU bailout nears

MADRID (Reuters) - Spanish Prime Minister Mariano Rajoy faces a cloudy return from his short summer break as his expected request for European aid in September will spur protests on the street and deepen cracks emerging in his conservative People’s Party.

Rajoy’s popularity plummeted in the first seven months of his 4-year term as his communications faltered while he enacted successive austerity plans and the euro zone’s fourth biggest economy sank into recession with unemployment over 24 percent.

With borrowing costs painfully high - the yield on Spain’s benchmark 10-year bond is unsustainable at close to 7 percent - Rajoy is expected to make a formal request for coordinated action from the euro zone rescue funds and the European Central Bank.

A rescue plan of EU buying of Spanish bonds, or a precautionary credit line, would reduce market tension but also come with harsh conditions at a time when protesters have taken to the streets against budget cuts.

The Socialist opposition rejected an earlier agreement for a 100-billion-euros European rescue for Spanish banks and is also against a sovereign bailout, and there are now even voices against it within Rajoy’s ruling People’s Party (PP).

Privately, senior party members have begun to blame Rajoy - an unlikely crisis manager with a cautious demeanor - as Spain is dragged deeper into the 2-1/2-year-old euro zone debt debacle.

While Rajoy has an ample majority in Parliament that has not shown signs of breaking, PP leaders in the country’s 17 autonomous regions have begun to rebel against tight spending controls that have forced them to cut back on hospitals and schools and face political backlash.

“We’re united behind him but it is not wrong to say that there is a diversity of opinions which are now being expressed,” a senior PP member told Reuters.

When asked if a cabinet reshuffle or even a change of prime minister was an option being considered in the party, the PP member said “in the current context, anything is possible.”

Analysts say Rajoy will probably have to make changes in his cabinet around the time he formalizes the request for aid, to appease disgruntled factions in the party and angry Spaniards.

“In order to make it politically digestible, the request for EFSF/ESM aid might come together with a cabinet reshuffle,” Citigroup said in a note to clients, referring to the European Financial Stability Fund and European Stability Mechanism, the EU’s temporary and permanent rescue funds.

MARKET, PEER PRESSURE

Spain has so far managed to continue selling sovereign bonds at public auctions, although paying a high price, and doesn’t face big debt repayment humps until the end of October.

For that reason the consensus view from financial analysts is that Rajoy will make an announcement in September accepting a two-year program.

Unlike the rescues of Greece, Ireland and Portugal, which removed them from markets for years, the idea is that Spain would continue to issue debt after receiving aid.

Rajoy, who returns from holiday the third week of August, last week said he needed to know more about the conditions for such a rescue, dubbed a “rescue-lite”.

The ECB is likely to provide details at its monthly meeting on September 6 and euro zone finance ministers are expected to discuss a potential program when they meet informally in Cyprus on September 14 and 15.

Analysts said the market had started to price in the rescue and a failure to act from Madrid would be a huge disappointment to investors who are now looking at the “when” and the “how” rather than the “if” of a bailout.

In its note, Citigroup said the total amount of European aid should cover gross issuance until mid-2014, or 306 billion euros ($380 billion).

This sum is in line with an indicative amount discussed between Spanish Economy Minister Luis de Guindos and his German counterpart Wolfgang Schaeuble at a meeting in July, according to a European official.

Rajoy’s European peers are also exerting pressure.

Mario Monti, prime minister of Italy, the next country in the firing line if Spain runs into trouble financing itself, is said to have pushed Rajoy to seek European assistance when they met in Madrid last week.

A source with knowledge of the matter said Monti suggested Rajoy ask for a primary market purchase of Spain’s debt by the European rescue funds and the ECB or for a precautionary credit line from the euro zone.

Rome hopes its own borrowing costs would come down as soon as markets see the ECB intervening to support Spain.

Rajoy’s comments last Friday that he was prepared to seek external aid sent Spain’s blue-chip index Ibex almost 15 percent higher and eased yields on European debt markets after they had reached new euro-era highs in July.

FALLING SUPPORT

A request for aid is likely trigger more street protests.

Support for Rajoy fell sharply after he was forced in June to seek a credit line of up to 100 billion euros to recapitalize Spain’s ailing banks and then announced a new package of spending cuts and tax hikes worth 65 billion euros.

According to an official poll released this week, if a general election were to take place now, Rajoy’s People’s Party would still win but would get only a 36.6 percent of the vote, down from 40.6 percent in a poll in May and 44.6 percent in the November vote.

Hundreds of thousands of angry Spaniards demonstrated in the streets of Spanish cities in July, with civil servants protesting daily for two straight weeks after their pay and perks were cut. New protests are scheduled in August and trade unions say they could call a general strike later this year.

Reflecting the widespread fear among Spaniards that a new bailout would come with tougher conditions attached, labor union leaders asked King Juan Carlos on Tuesday to mediate with the government to organize a referendum if further cuts were to be on the cards.

“We expressed our opposition to a possible second rescue of the Spanish economy from European Union institutions because it would come with a series of conditions which would push us into a recession which would be very difficult to exit in the next years,” the union leaders said in a statement after the meeting.

During a visit to Berlin this week, Socialist opposition leader Alfredo Perez Rubalcaba also said he would work to convince the government not to seek a bailout as it would come with increased international control of the Spanish economy. ($1 = 0.8052 euros)

Edited by Fiona Ortiz and Peter Graff

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