June 1, 2018
Turmoil in Euro Area Spreads as Rajoy’s Government is Ousted in Spain
By Alvaro Morales Salto-Weis and Bart Oosterveld
Rajoy’s startling ouster marked the first time Spain’s leader has been toppled in such a way since the country transitioned to a democracy in 1978. Pedro Sánchez, the leader of the main opposition Socialist Party (PSOE), will succeed Rajoy and is expected to call early elections.
While Southern Europe is gripped by a political crisis, the situation in Spain and Italy is different. In Spain, the crisis stems from internal discontent over corruption, rather than the economic discontent that has fueled populist, eurosceptic parties in Italy. In fact, Spain’s economy is performing strongly, above the EU average in terms of growth, and any new government coalition is likely to have marked pro-EU views.
How did we get here?
Rajoy was elected prime minister of Spain in 2011. While his minority government had the support of a slim parliamentary coalition, his government enjoyed relative stability. It survived a controversial independence referendum in the northeastern region of Catalonia in the fall of 2017. The government presided over an improving economic situation, had recently passed a hard-fought budget for the coming year, and was expected to complete its mandate until scheduled elections in 2020.
Last week, however, Spain’s high court convicted several former high-ranking officials from Rajoy’s conservative party (Partido Popular or PP) in one of Spain’s largest corruption scandals in modern history. PP was found to have benefited from “efficient and institutional” graft between 1999 and 2005—a time when Rajoy held key positions within government as well as within PP. While he was not personally charged, Rajoy’s witness testimony was found to be “non-credible.”
The court’s ruling set in motion an increasingly fierce reaction by opposition parties, particularly PSOE. Its leader, Sánchez, called for a no-confidence vote on Rajoy and proposed himself as next prime minister. Sánchez’s high-risk gamble was emboldened by Rajoy’s underestimation of the significance of the court’s ruling.
PSOE has since gradually, and rather unexpectedly, mustered the support of a heterodox coalition of smaller parties, ranging from far-left Podemos to separatist Catalan groups and Basque nationalists. While PP has derided this as a “Frankenstein coalition,” it was unable to avoid Rajoy’s ouster, losing the vote 180-169. PP’s junior partner, center-right Ciudadanos, voted in favor of Rajoy.
What happens now?
Sánchez will be appointed prime minister by Spain’s King Felipe VI as soon as June 4. His PSOE government, however, will not enjoy majority support of parliament. He has vowed to call elections soon, although no specific date has been given. Observers expect new elections no sooner than August, probably later. Until then, no dramatic policy changes are expected. Notably, Sánchez’s promise to respect current budget priorities, including deficit reduction, was key to him winning the support of Basque nationalists.
Sánchez’s government will be marred by instability. PSOE only holds about a quarter of the seats in parliament and recent polls show it would struggle to maintain a similar outcome in the next elections. Furthermore, Sánchez’s appointment as prime minister reflects a rejection of Rajoy rather that true support for his candidacy. He will be under pressure from a wide range of parties that supported him this week. These parties have very different priorities and are already gearing up for the elections.
Finally, the separatist government in Catalonia could exploit the weakness of Spain’s central government.
The new election promises to deliver a fragmented result that may complicate governability. Similarly, the 2015 election resulted in an extended period under a caretaker government. Recent polls point to a surge in support for center-right Ciudadanos (currently holds thirty-two seats), which would become the largest party in parliament. PP (137 seats) would suffer heavily, dropping to fourth place. Center-left PSOE (eighty-five seats) and far-left Podemos (seventy-one seats) would remain more or less stable. However, the landscape may evolve rapidly.
What are the economic and international consequences?
So far, this is a political crisis, not an economic one. However, protracted political turmoil could end up triggering a self-inflicted economic wound. Spain’s economic fundamentals remain strong, with GDP advancing at 3.1 percent last year and slightly less in 2018. Public debt remains elevated but stable at around 98 percent, and the government’s deficit is set to meet EU limits of 3 percent for the first time in more than a decade. Unemployment, which remains very high at around 16 percent, is lowering at a steady pace. The banking sector has markedly improved its health since the financial crisis.
However, Spain’s economy faces several challenges. For one, it is ill-prepared to sustain contagion from a global economic downturn, with little room for fiscal maneuvering and monetary policy outside of its control. Already we have seen concern over the political crisis in Italy spread to the Spanish stock market (which has fallen by 5 percent in the past month).
The spread between Spanish and German government bonds, which is a closely watched indicator of risk, has also risen by about 50 percent in the past week. Additionally, any eventual monetary normalization by the European Central Bank (ECB) will raise financing costs for the Spanish government and corporate sector, exposing the fragility of still elevated public and private debt loads.
Internationally, Spain’s instability marks a setback for the EU ahead of a decisive meeting later in June where important steps regarding the United Kingdom’s exit from the EU—Brexit—and economic reform will be discussed. Developments in Spain will be particularly harsh for French President Emmanuel Macron who counted on Rajoy’s support for his ambitious reform proposals for deeper EU economic and fiscal ties. German Chancellor Angela Merkel, too, will lose an important conservative ally with Rajoy’s exit.
Alvaro Morales Salto-Weis is a program assistant in the Atlantic Council’s Global Business and Economics Program. Follow him on Twitter @alvarosaltoweis.
Bart Oosterveld is the director of the Atlantic Council’s Global Business and Economics Program.