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The Spanish economy is currently trapped in the heavy shackles of debt, leading to harsh spending cuts and perhaps intolerable levels of financial hardship among the people. This became more evident when Standard and Poors (S&P) downgraded Spain’s rating by two notches.
Spain’s rating was downgraded from an A to a BBB+. This is the second time the rating was lowered within a year, leading to widespread fear and uncertainty over Spain’s fiscal conditions. Unfortunately, this is just part of an overload of bad news for Spain, along with unemployment reaching a record high of 24.4 percent and confirmation from the central bank that Spain is in recession for the second time in three years.
Debt and budgetary problems appear sovereign, but others should not be impacted even by its sheer scale. The problem is the movement of capital between nations, leading to the vicious cycle of debt. When fiscal imbalances erupted in Greece a few years back, they seemed to have transmitted unequivocally, like a deadly virus. After Greece’s announcement, another debt bomb exploded in Italy, again in Spain, and again in Portugal. Greece was the first of multiple incidences of crisis.
Countries in debt struggle with a clash of recession and fiscal inefficiency in terms of debt management. One smooth way to get rid of debt is to increase tax rates so that the state can repay it and reduce interest burden. But a tax rate increase requires sound and consistent growth rate, which can rarely be found in the short-term.
Another major problem associated with public debt is a rise in the cost of borrowing in domestic as well as international markets, leading to complications in finding sources to repay it. In Spain, the economy contracted by o.3 percent in the last quarter of 2011. Bringing back a growth rate that can complement a rise in tax rates is a distant dream in the short term. On an annual basis, GDP slipped by 0.4 percent.
Debt problems have both micro and macroeconomic implications. At the microeconomic level, the households feel the heat of debt in terms of a rise in cost of living and a rise in interest rate in the initial stages of a problem.
At the macroeconomic level, public debt seems to grow if the ratio of debt to GDP is bigger. According to Global Finance magazine, Spanish Debt-GDP ratio was 56 percent in 2009. In 2012, the ratio stood at 79.8 percent, a troublesome turnaround.
Out of the 100 percent of what a country produces, it is required to pay almost 80 percent to creditors, even at a time when the economy is struggling to get back to normalcy. If, somehow, a country reduces its debt load, then stiffer austerity measures are hardly necessary.
Smooth functioning of the economy acts as a cushion while fighting with debt. Because debt and growth in GDP are inversely related, when the GDP growth rate is higher debt can easily be warded off. But when the debt component is greater than GDP rate, the country faces crisis.
Ireland recently reported negative growth, along with Slovenia, Belgium, the Netherlands and Cyprus. In addition, members of the European Union like Denmark, the United Kingdom and the Czech Republic are already in a recession. It will take a lot of work and a great amount of change to help Spain’s economy pull out of the crisis it has fallen into.
Image Courtesy of PPCYL – Partido Popular de Castilla y León