No Fines for Iberia, but Remedial Action Demanded and Possible Loss of Some ESI Funds

The eurozone finance ministers have accepted the EC’s recommendation that
Spain and Portugal not be fined for their fiscal excesses. 
A few
weeks ago, the EU Commissioner for Economic Affairs, Moscovici explained that
punitive actions would strengthen anti-EU sentiment.   However, that consideration did not prevent the EU
from threatening to cut off part of the European Structural and Investment
(ESI) funds for next year.

The threat of reducing ESI funds can easily be
  Both countries have to move toward compliance with the Stability and Growth Pact and enact
the policy recommendations of the EU.  Portugal must take corrective
action to bring the budget deficit to the 3% of GDP threshold.  Last
year’s shortfall was 4.4%.  That seems optimistic, especially if growth is
slower than the 1.3% year-over-year pace the government expects.

Spain has until 2018 to bring its budget deficit to 3% of GDP. 
The deficit stood at 5.1% in 2015.  While Portugal elected a left of
center government last year, Spain has been unable to break the political
logjam.  It has held two elections and still has not been able to cobble a
government together.   However, a potential breakthrough has
occurred.  The new centrist party Ciudadanos has set conditions for its support.

Previously, Ciudadanos refused to support Rajoy due to unresolved
corruption allegations, but its new demands may prove just as onerous for Rajoy
and the PP.
  The demands include
a new parliamentary committee to investigate the slush fund that was allegedly used.  There are several
judicial investigations.  Ciudadanos also wants to remove the protections for senior officials and lawmakers from
legal cases.  Any politician named in a court corruption probe must step down, and the government should be barred from granting pardons in such cases.

Also,  a new electoral law is sought
that would establish an eight-year term limit for the prime minister and reduce
the advantage of rural voter over urban voters. 
Since the PP does not
have a majority, there may be little it can do about the corruption
investigations.  Parliament could push ahead with this even if the PP did
not agree.  Therefore it makes little sense for the PP to object.  It
is giving up something it does not have.  The electoral reform is
reportedly a more difficult pill for Rajoy to swallow.

Ciudadanos has 32 seats, while the PP has 137.
  Together they would be
seven seats shy of a majority in the 350-member chamber.   If Rajoy
and the PP agree to the conditions, then pressure turns to the Socialists,
which are the second biggest party.  They won 85 seats in June. There is
some thought to avoid yet another election, the Socialists could abstain, and in
so doing, allow a PP-led minority government.

To “demonstrate full
compliance with the Pact”, Spain is required to make a 0.5% fiscal
adjustment and Portugal 0.25%. 
The EC is deferring a final decision
on suspending structural funds until at least next month.  Effective
action is expected to be taken and
formally report the details in the middle of October, at the same time as they
present the draft 2017 budget plans.

No country has been fined for the
lack of fiscal progress. 
the Great Financial Crisis, Germany and France avoided similar penalties. 
On one hand, the absence of fines undermines the credibility of the Stability and Growth Pact.  On the other
hand, like other rule-based regimes, exceptions and exemptions are built into
the rules themselves, like fouls in many sports.  Moscovici argues that
the rules give room to cancel fines.  The Commissioner also noted that
more countries respect the rules now than when there were first introduced.

This Great
comes from the Financial
    It shows the 2015 deficits for selected
European countries and this year’s projections.   The projected
progress of Greece is remarkable, while Spain is projected to have the largest
shortfall.    Weak growth prevents the denominator for
contributing to the reduction of the deficit-to-GDP ratio.  However, that
is not the problem for Spain.  It grew an enviable 3.2% last year. 
The median economist forecast is for around 2.8% this year, which, ironically
is 0.1% above the government’s estimate.

ECB bond buying and the quest for yield offset the political and fiscal
In the year-to-date, Spain’s 10-year yield is off 81 bp. A
quarter of this was scored in the past
month. The yield is off five bp today and
is at a new record low of 95 bp. In comparison, Italy’s 10-year benchmark has
not penetrated the 1.0% threshold.  Portugal’s 10-year benchmark bond has
fallen nearly 32 bp over the past month, which has cut the year-to-date rise to
23 bp.  

The euro seems immune to these developments.   It trended higher
from the ECB’s disappointment last December (after reaching ~$1.0525 low) to a
high in early-May (~$1.1615).  It has trended lower since then and hit a
low near $1.09 in response to the UK referendum results.  Since then it
has managed to close above $1.12
once.  A trendline drawn off the May
high and the pre-Brexit high (~$1.1430) intersects today near $1.1270.  In
a week’s time, it is found near
$1.1240.    The $1.1265 area also corresponds to a 50%
retracment of the euro’s decline since early-May (the 61.8% retracement is near

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