Speaking to the press after the meeting of EU leaders earlier this month, Spanish Prime Minister Mariano Rajoy (see picture) surprised everyone by declaring that Spain had taken the "sovereign decision" to ignore the deficit reduction target of 4.4% of GDP agreed with the European Commission for this year.
As we pointed out here (and as Simon Nixon pointed out in the WSJ yesterday), the Commission had two options to cope with this situation: hardball or flexibility. And it has gone for the latter, although still asking Spain to bring its deficit down to 5.3% of GDP by the end of the year - that is, 0.5% lower than the 5.8% announced by Rajoy. This translates into an extra €5 billion of savings by the end of the year, something which Rajoy says Spain reasonably can achieve.
Leaving the bailouts aside for a second, Spain's behaviour may well be a hint at the true meaning of "economic governance" in the eurozone - constant bickering about who actually is in charge, the 'sovereign' member state or the European Commission (or some other vehicle of the Eurogroup).
In any case, the compromise 'deal' between the Spanish government and EU finance ministers gives rise to a number of questions:
Is this a victory for the Spanish government? Not at all. Despite Rajoy's efforts to sell it as such at home. Spain has only obtained a revision of its deficit target for 2012, but is still expected to cut its deficit to 3% of GDP by the end of 2013. In other words, the Spanish government is only kicking the can down the road and will have to make much tougher budget cuts next year in return for dodging them this year.
Is this a victory for the European Commission? Not really. At the end of the day, the Commission has allowed Spain to run a higher-than-agreed deficit for 2012. Needless to say, this did not go unnoticed. Explicit criticism has already come from Belgium and Austria, with the latter accusing the Commission of using "double standards" as Hungary - at the same meeting of finance ministers - saw almost half-a-billion euros of subsidies frozen for failing to comply with EU deficit rules.
Furthermore, Dutch Labour MPs have threatened to block the ratification of the new 'fiscal treaty' on budgetary discipline unless the Netherlands - like Spain - is allowed more time to put its own house in order. Dutch Prime Minister Mark Rutte’s coalition government needs the support of the opposition to pass the 'fiscal treaty' in parliament, as Geert Wilders’ far-right PVV party will vote against it.
The pact would still come into force if the Netherlands failed to ratify it - twelve eurozone ratifications would be sufficient. However, Triple-A countries are a rare breed in the euro area these days, and if one of them were to stay out, the 'fiscal treaty' would lose even more of its credibility. Uncertainty remains, but the Commission might really have opened a Pandora's box by revising Spain's deficit target for this year.
But are these targets even achievable? Almost certainly not. Spain's economy is expected to contract by 1% this year. Furthermore, the Spanish government has 'only' adopted a first package of around €15 billion in spending cuts and tax hikes, meaning that savings worth some €20 billion are necessary to meet the revised target for this year. Both of these facts are likely to increase the already sky-high unemployment rate. It's too early to tell whether the Spanish population is willing to stomach this. A new general strike against the Spanish government's labour market reform has been scheduled for 29 March - it won't be the last one.
The deficit target of 3% of GDP for 2013 looks even more out of reach - especially if this year's target is missed. As Rajoy told MPs yesterday, Spanish regions must be prepared to make "bigger" cuts, but some important Spanish regions (including Andalucía, where Rajoy's Partido Popular could win a majority after the 25 March elections, and wealthy Catalonia) do not seem particularly keen on taking more austerity. This is complicated by a feeling that the cuts are being 'imposed' by the central government. If the Spanish government fails to keep the regions on board, the chances of meeting the budget commitments look very slim indeed.
What's clear is that Spain will become a major testing ground for the effectiveness or otherwise of the eurozone's new economic governance structure.