Iberians face euro cold shoulder

Date: 24/04/1997

“HE WHO has once advanced by a stride will not be content to advance afterwards by steps.”

These 150-year-old words from British writer Henry Taylor could hardly be more appropriate to describe the current predicament of the Spanish and Portuguese authorities as they complete their headlong dash for single currency membership.

Only 25 years ago, the two countries were backward, fascist-run outposts of Europe. Today, they stand on the borders of the promised land: monetary policy run from that home of price stability, Frankfurt.

However, through no fault of their own, Spain and Portugal are all but certain to be asked politely to move aside as a first wave of countries swap their currencies for the euro in January 1999.

Italy stands in their way and, since the politics of European economic and monetary union are as important as its economics, it is more than a minor stumbling block.

As a founding member of the European Communities and one of the continent's four Group of Seven economies, Italy cannot be deliberately slighted. Letting the come-lately Iberian twins (who only joined the Union 11 years ago) into its exclusive monetary club ahead of an established - if rather disreputable - old-timer would be seen as exactly that.

Try as they might, Spain and Portugal simply cannot shake off the 'Club Med' tag.

Their politicians hate the nickname - the Portuguese especially since they are, if anything, an Atlantic power. But with Greece out of the EMU equation, the Spanish and Portuguese find themselves forever lumped together with the Italians as 'southerners'.

Thus it is that Italian misdemeanours tend to reflect badly on them. In the past year, neither Madrid nor Lisbon has introduced a one-off 'Euro-tax' to be repaid two years later, nor brought forward pre-planned tax hikes to massage their 1997 budget figures. But most people think they have just because they are 'Club-Medders'.

While they know better, the economic establishments in Germany and its monetary satellites nevertheless share a misgiving that Spain's conversion to the cause has been a little too swift.

The Dutch and the Belgians have been indulging in year-in, year-out budgetary rigour since 1982, and they and the Austrians have super-glued their currencies to the deutschemark for many years.

The track record of Spain and Portugal is considerably shorter.

Without naming names, German Bundesbank President Hans Tietmeyer made it clear after the recent informal meeting of EU finance ministers in Noordwijk that euro-wannabes must achieve genuine 'convergence' rather than relying on the financial markets to do it for them.

In other words, governments must cut current public spending to a level where it can be financed by revenues and choke off consumer price inflation.

Encouraging 'convergence plays', whereby investors believe so ardently that EMU membership is coming that they will buy government debt and thus slash the cost of refinancing it and consequently reduce the budget deficit, is no substitute for genuine convergence.

This is a fair complaint in the case of Italy - but for Spain and Portugal, it is hard to swallow.

On the face of it, both countries are on course for membership of EMU in 20 months' time, with Portugal leading by a nose.

Lisbon's budget deficit was 4&percent; of gross domestic product last year and - with GDP growth set to top 3&percent; this year - the chances of dipping the deficit below the 3&percent;-of-GDP entry target for EMU are high. The escudo is stable and has not devalued within the Exchange Rate Mechanism since March 1994, when it was arm-twisted into a 3.5&percent; depreciation by other member states.

For the second year in a row, the value of Portugal's public debt will shrink - declining to 64.5&percent; of GDP from 67&percent; in 1995. Although non-EMU economic indicators such as wealth per head or quality of infrastructure would put Portugal far behind its northern counterparts, the goals Lisbon was set at Maastricht have been all but met.

As so often in its recent history, the path of the Portuguese government led by Antonio Guterres will be marked out by the country's much bigger neighbour. But, even there, economic progress is clear.

The Socialist government of Felipe González dragged Spain out of the economic Middle Ages to which it had been condemned by Franco, but was guilty of the very 'convergence play' identified by Tietmeyer.

From the moment the peseta was taken into the ERM in 1989 until the beginning of the mechanism's crisis three years later, the González government relied heavily on massive inflows of 'hot money' investment.

The world's bankers found Spanish currency deposits and bonds irresistibly attractive - with no devaluation threat because of its ERM link, the peseta was a substitute for the deutschemark in their portfolios but the interest rates on offer were much higher.

Of course, as it turned out, this was a grand delusion. The convergence programmes of González and his Finance Minister Pedro Solbes were always wildly optimistic, to put it kindly.

As a recent report from investment bank Salomon Brothers shows, the 1992 programme factored in continued economic expansion in 1993-95 at a time when the Spanish economy was already facing up to recession and the second plan in 1994 assumed average GDP growth of 3.5&percent; in the coming years when 2.5&percent; was the norm.

For all its faults, the Popular Party government of José María Aznar has been mostly scrupulous in its forecasting and aims. Two weeks ago, the cabinet approved a new medium-term fiscal plan which aims to reduce the budget deficit to 1.6&percent; of GDP by the end of the century.

Unlike their counterparts in Italy, Spanish politicians are making a good fist of tackling the structural aspects of their public spending overshoots.

Pension reform is under way and public-sector employment growth frozen, while agreements have been reached with the labour unions to restructure the armaments, shipbuilding and coal mining industries.

Some might complain that the speed of the cuts in coal subsidies is slow - aiming for a halving of aid by 2005 - but no German politician could do so with a straight face.

And these are just the long-term structural measures. Performance in this crunch year for EMU applicants looks equally good. The finance ministry has already announced that tax revenues in the first three months of the year are 500 million ecu better than had been anticipated in the 1997 budget, and GDP growth looks set to hit 3&percent;-plus.

Inflation is also coming under control. Price rises were capped at 2.5&percent; in February and are expected to dip to an annual rate of 2&percent; in the early summer. Wage settlements in the first quarter grew 3.1&percent; on the year, but this was down from a 3.8&percent; average last year.

Structurally, the workforce seems to be drifting into a new type of job with lower wages, fixed terms and a larger part-time sector. The only cloud on the horizon is the threat of importing inflation with the recent depreciation of the peseta.

Spain's greatest problem has been its staggeringly high rate of unemployment, which has stood consistently at more than 20&percent; of the labour force. Yet, even here, the country is one of the only states in continental Europe to have generated jobs during the economic recovery of the past three years.

None of this is likely to count for very much in April-May of next year when the decision on EMU's short-list is taken.

As they kick their heels in the euro-zone antechamber from 1999 to 2001, the Iberians will be forgiven for feeling deeply aggrieved.