No firewall for euro fears

As investors fret over the size of the boost to Europe's rescue fund, markets are also deeply worried Spain will be unable to meet its ambitious deficit reduction goals.

Global markets face a challenging week, after Brussels’ latest attempts to stave off the eurozone debt crisis – boosting the eurozone’s firewall to €800 billion ($US1.07 billion) on the same day as the new Spanish government Mariano Rajoy unveiled a massive cut in its budget deficit – failed to lift investor confidence.

Instead, both actions only fuelled market skittishness. Investors quickly figured out that the €800 billion firewall – which was supposed to provide proof that the eurozone had ample resources to rescue Spain – included around €300 in bailout loans already made to Greece, Ireland and Portugal.

At the same time, investors were doubtful that Spain could meet what its budget minister, Cristbal Montoro, described as "the biggest fiscal consolidation of the democracy” given the country’s flagging economy and explosive 23 per cent unemployment rate.

Spain has announced spending cuts and tax increases of more than €27 billion in an attempt to reduce its budget deficit to 5.3 per cent of GDP this year, from 8.5 per cent last year. However, there are already doubts as to whether Spain’s autonomous regions – which account for one-third of public spending, including on education and health – will be able to meet the ambitious deficit reduction targets set by Madrid. The regions have seen their tax revenues collapse since Spain’s property market bubble burst in 2008.

Markets are now deeply worried that Spain will find it near impossible to meet its ambitious deficit reduction goal. Investors fear that spending cuts will plunge the economy into an even deeper recession, pushing tax revenues lower at the same time that spending on unemployment benefits will rise. In recent weeks, Spain’s borrowing costs have crept higher as investors fretted that the Spanish economy – the fourth largest in the eurozone – is slowing sharply. Yields on 10-year Spanish bonds have climbed to 5.35 per cent, from 4.85 per cent in the past month.

Meanwhile, Germany is clearly becoming increasingly impatient that debt-strapped eurozone countries are failing to implement even more rigorous cuts to their budget deficits.

According to an article in the German publication Der Spiegel, German finance minister Wolfgang Schuble is supporting a plan to set up expert committees that would be responsible for supervising the national budgets of eurozone countries, and for keeping a watch out for "abnormal developments” that could result in a crisis.

According to an internal document from the German finance ministry, the new committees would also make sure that the national budgets of eurozone countries complied with the region’s new "fiscal stability pact”, that sets out strict deficit and debt rules.

But this latest German initiative is likely to be rebuffed by countries such as Spain and Italy, which are deeply suspicious of what they see as attempts by Berlin to dictate their national budgets.

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