However, Spain doesn't pose the same threat as Italy and Greece

We've seen this before: a European country with high debt levels, interest rates on 10-year bonds spiking, and a change in leadership. Add to that Spain's badly faltering economy -- with unemployment over 20 percent -- and the country looks a lot like Italy and Greece, whose high debt levels and leadership shakeups have recently roiled markets and rattled the Eurozone.

[See why the OECD thinks major economies are headed for a slowdown.]

The Spanish people rejected the ruling Socialist government in favor of the center-right Popular Party, electing Mariano Rajoy as the new prime minister and handing the party an absolute majority in parliament.

Yet the results of the election highlight the gap between Spain and its southern European brethren. Markets were unwilling to trust former Italian Prime Minister Silvio Berlusconi's repeated promises of austerity, and the threat of a referendum on budget-cutting measures in Greece caused widespread European panic. Yet the Spanish people this weekend willingly chose the party promising reform and belt-tightening, risking economic hardship in the near future.

"This is the country in Spain with by far the highest unemployment rate, yet in this election the Spanish people overwhelmingly voted for the most fiscally austere and generally pro-reform-minded party," despite the presence of populist alternatives, says Jacob Funk Kirkegaard, research fellow at Peterson Institute of International Economics.

Indeed, though Spain is certainly far from healthy economically -- and markets agree, with the yield in the Spanish 10-year bond at nearly 7 percent -- there are plenty of other reasons why Spain is not the European problem child that markets feared Italy and Greece were.

For one, Spain's debt-to-GDP ratio of roughly 65 percent is nowhere near Italy's 120 percent. In addition, Kirkegaard says that, unlike Italy, Spain has a low "implementation risk" -- that is, when the country says it is going to cut spending and make structural changes, there is little reason not to believe it. Indeed, the country showed its commitment to budget strictures earlier this year by putting a balanced budget amendment in place.

That willingness to effect change could be doubly good for Spain, says Kirkegaard.

"Even if the [European Central Bank] isn't going to do so preemptively, it will reward a country that has done a lot of fiscal austerity" and appears willing to enact structural reforms, he says. "Whereas the ECB was clearly quite happy to hang Berlusconi out to dry, that isn't the case so much with the Spanish government."

Assuming many European countries go through with implementing austerity measures, as Spain appears likely to do, the reduction in government spending could further diminish GDP. Earlier this month, the European Commission reduced its euro zone growth rate forecast from just under 2 percent to 0.5 percent, edging the region even closer to recession.

The hope is that a few quarters of slow or even negative growth will ultimately pay off as countries diminish their debt levels, reform their economies, and hopefully reemerge stronger on the other side.

 

 

 

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