Spain is too big to fail but Hungary must face the music

You’ve probably seen the headline on Spain. The Wall Street Journal sums it up well:

"Spain is absolutely committed to budget adjustment and is absolutely committed to structural reforms, so from this point of view, that recommendation will be accepted by the government of Spain," Spanish Finance Minister Luis de Guindos said Tuesday said on his way into a second day of meetings with EU finance ministers.

On Monday, the finance ministers of the 17 countries that use the euro asked Spain to cut a budget deficit by 0.5 percentage point more than Spain had planned in 2012 after it unilaterally revised its target higher.

Spain Agrees to EU Budget Demands

The real target was a 4.4% deficit but Spain unilaterally increased this to 5.8% and were worked back to 5.3% in negotiation. While there had been talk about sanctions for this move, it is now clear there will be none for Spain. Meanwhile Hungary must face the music. The EU will likely freeze nearly 500 million euros in structural funds for Hungary as Prime Minister Orban failed to make his targets.

What makes for the differential treatment? I think you could make a case that Hungary has acted in bad faith i.e. it has moved to a more authoritarian governing regime. That mixed with its law to allow mortgage borrowers to pay off foreign currency loans at a fixed exchange rate lower than the market rate makes them a free rider in EU eyes. Spain on the other hand is making the structural adjustments and has a debt to GDP below the EU average. Given the record unemployment this has created, they are rightly seen as going the extra mile on austerity and adjustments. So Spain has been rewarded with a free pass and Hungary will be punished.

The previous paragraph’s narrative is the one that the EU wants told. But there is also an undercurrent of some being more equal than others. Clearly Spain has flouted the rules brazenly and they have effectively been rewarded for doing so. Yes, they were worked back in negotiation but the bottom line is there have been no consequences for their unilateral decision to miss targets. To me this speaks to Spain’s status as a too big to fail country. The EU is deathly afraid of either Spain or Italy getting into trouble and will do almost anything these countries ask. Spain had to know this and that’s why they felt comfortable disregarding EU policy entirely.

Italy take note.

This should definitely underpin Spanish and Italian bonds as it is further evidence they will be supported at all costs. It also gives a slight boost to Spanish (and Italian) equities since downside risk is more limited.

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