Spanish Prime Minister Mariano Rajoy's administration is negotiating on two fronts. First, it is discussing the terms of the bailout for its banking sector after the European Union guaranteed up to 100 billion euros ($131 billion) in aid for Spanish banks in June. Second, Madrid wants assistance from the European Central Bank, which in early September announced a program to buy bonds on secondary markets to suppress borrowing costs for countries under high pressure in the markets. This program applies only to countries that formally request support from the European Stability Mechanism, Europe's permanent bailout fund, and is subject to conditions imposed by the European Union. These conditions are championed by Germany, which believes that countries receiving this kind of assistance must commit to economic reforms. Germany fears that European institutions' intervention in the debt markets would lead countries to relax their policies of fiscal discipline.
The Rajoy government is divided between those who believe an agreement should be reached immediately with the European Central Bank and European Stability Mechanism and those who want to wait. Spanish media reports indicate that Economy Minister Luis de Guindos is pushing for an immediate request for assistance from the European Central Bank to lower Spain's risk premium. In de Guindos' view, Spain could benefit from a mechanism that has never been implemented before, since it would give Madrid the opportunity to negotiate favorable terms.
But Rajoy believes that Madrid does not have to make a decision right away. The recent announcement that the European Central Bank may buy Spanish debt and the German Constitutional Court's recent approval of the European Stability Mechanism have brought some calm to the financial markets.
Moreover, Rajoy wants to minimize the conditions that the European Union could request in return for the bailout. On Sept. 14, de Guindos announced that Spain is considering new economic reforms that have not yet been determined. Spain's strategy is to implement reforms before asking for assistance in the debt markets to prevent an agreement with the European Union that would involve constant monitoring of the Spanish economy similar to the regular visits that officials from the European Union and International Monetary Fund make to Greece, Ireland and Portugal.
Rajoy is also delaying the decision for political reasons. The autonomous regions of Galicia and the Basque Country will hold elections Oct. 21. Rajoy believes that asking for yet another bailout will be unpopular at home and would undermine his party's chances in regional elections. Rajoy could continue with negotiations for the bailout but not make a formal request until after the elections. Despite the internal discussions and divisions within the Cabinet, Rajoy's position probably will prevail.
Other Countries' Interest
Italy is particularly interested in the negotiations between Spain and the European Union. Like Spain, Italy has enjoyed a few weeks of relative calm in the bond markets following the announcement of the European Central Bank's program and the ratification of the European Stability Mechanism by the German Constitutional Court. Rome believes that if EU institutions assisted Madrid, Italian bond yields would drop because of the resulting boost to the credibility of the European Union. Moreover, if Madrid gets an advantageous agreement with the European Union, it would set a precedent for Rome should it need a similar agreement. However, Italian Prime Minister Mario Monti hopes to avoid formally requesting help from the European Union and that assistance to Spain will be enough to bring Italy's yields down.
Ireland is also closely following Spain's negotiations with the European Union. In November 2010, Dublin received a sovereign bailout that was largely used largely to rescue its banking sector. Since then, Dublin has been trying to reduce the weight that the Irish bank bailout represents on the Irish sovereign debt.
EU leaders pledged at a summit held June 28-29 to "break the link between bank bailouts and sovereign debt." During the summit, officials agreed that banking debt bought up by the European Stability Mechanism would not in the future count as sovereign debt. However, Ireland's strategy has concrete institutional limits. European leaders promised that Spain — and therefore Ireland — would not be liable for their bank bailouts but only after the European Union created a banking union.
The European Commission presented a proposal for a banking union Sept. 12, but such a union probably will not be created this year. As a result, Dublin will be following Spain's negotiations closely, expecting to receive similar treatment once Madrid and its lenders reach an agreement.
After it completes negotiations for its banking bailout, Spain will be under increasing international pressure to decide whether it will formally request help from the European Union to suppress its borrowing costs. Other eurozone countries will take cues from Spain's decisions. Rajoy and Irish Prime Minister Enda Kenny will hold bilateral meetings with Monti on Sept. 21 at a summit of Christian Democratic parties. After those meetings, the three leaders will have more clarity about what to expect from other players in the eurozone's periphery.