Market Overview

Spain Says It Intends to Miss Promised Budget Targets

Shortly after signing an agreement with 25 other European Union leaders for a new fiscal treaty that would punish euro zone countries that failed to meet budget targets, Spanish Prime Minister Mariano Rajoy dropped the bombshell that Spain was going to run a bigger 2012 deficit than the one it had agreed to earlier. Spain's acknowledgment that it planned to ignore its earlier budget promises could send a signal to the markets that European leaders aren't serious about balancing their budgets, despite the much talked about fiscal compact that they just agreed to.

Instead of coming up with a budget that would run an estimated deficit of 4.4 percent of gross domestic product (GDP), Spain now plans to run a deficit of 5.8 percent of GDP. Prime Minister Rajoy tried to reassure the markets that Spain was dedicated to meeting the 2013 budget deficit target of 3 percent of GDP.

Although there might be a lot of disappointment that Spain plans to run a bigger than expected deficit, the reasoning behind Spain's decision is understandable. The country has the highest level of unemployment, with nearly half of its young adults out of work. Spain just announced that unemployment is rising and that the country is falling deeper into recession. Spain now says that it expects its economy to contract by 1.7 percent this year, worse than a 1.5 percent prediction from just one week ago, while the European Commission had forecast an economic contraction of just 1 percent for Spain.

The Spanish government might actually be worthy of praise for its actions instead of rebuke. Instead of following the example set by Greece, Spain is being more honest about its budget planning. The Spanish government is also giving the market a more realistic idea of where the Spanish economy is headed, compared to the rosier outlook provided by the European Commission.

Countries like Greece, Spain and Portugal have long complained that the euro zone response to the sovereign debt crisis has focused solely on reducing deficits. They say that the problem with budget cuts is that they cause the economy to shrink, which leads to lower tax revenue and further rounds of budget cuts. Greece and Spain have asked other European leaders to come up with economic plans that focus on growth instead of austerity.

The Spanish decision could also be seen as a preemptive strike against social unrest caused by the country's extremely high unemployment rate. The widely unpopular austerity measures that Greece agreed to in order to receive bailout funds have pushed that country deeper and deeper into recession and have led to nationwide strikes and violent protests. Because of this situation, many wonder whether the Greek government will be able to stick with its austerity measures or be forced to bow to the protesters' demands.

Spain could be trying to get ahead of this potential problem by showing the Spanish people that the government is willing to stand up against Europe for the good of the Spanish people. Shortly after signing the new fiscal compact and announcing that Spain would not meet earlier agreed to budget deficit targets, Spanish Prime Minister Mariano Rajoy said that he had not consulted with other European leaders before making his decision. He said that he was putting Spanish interests first and the issue was a question of Spanish sovereignty. His words must have resonated with protesters in Greece, Spain and Italy who have complained that their countries are giving up national sovereignty to Germany and Europe.

It's too soon to tell whether or not Spain is being reckless but investors might want to consider the fact that the country is being honest about the direction its economy is headed and about how it plans to deal with it. The Greek way of dealing with the sovereign debt crisis has been a disaster, so maybe Spain will how Europe a better alternative.


ACTION ITEMS:

Bullish:
Traders who believe that Spain's plan not to focus entirely on austerity will work better than the Greek approach might want to consider the following trades:
  • Spanish stocks like Telefonica (NYSE: TEF) and Banco Santander (NYSE: STD) could do well if Spain's decision to scale back its austerity measures leads to better economic performance.
  • The iShares MSCI Spain Index (NYSE: EWP) ETF is another option for investors who would prefer a more diversified Spanish investment.
Bearish:
Traders who believe that Spain's unilateral decision to have a bigger than expected deficit in 2012 may consider alternative positions:
  • The ProShares UltraShort Euro (NYSE: EUO) and the ProShares UltraShort MSCI Europe (NYSE: EPV) could see their share prices climb if investors feel that Spain's decision is a sign that troubled euro zone countries will continue to run up their deficits. The euro and European stocks could fall if investors lose confidence in euro zone countries' ability to lower their deficits.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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