Belt tightening in the board room and the living room, deep public budget cuts and anemic bank lending may be setting Spain up for years of economic stagnation that could eventually force it to seek a bailout. Under pressure to chop Spain's deficit to the European Union limit and stick to new fiscal rules, Prime Minister Mariano Rajoy has promised to present a budget on Friday that will be "very, very austere."
With the economy on the verge of its second recession in three years, soaring unemployment and rising borrowing costs, some economists are predicting a lost decade of growth such as the one experienced by Japan in the 1990s from which it has never fully recovered. Others, including Italian Prime Minister Mario Monti, say Spain could drag the euro zone back into a deep crisis.
"We've signed a suicide pact in Europe by agreeing that we all need to make cuts," said Luis Garicano economist at the London School of Economics and head of Spanish think tank Fedea. "Europe has to recognize that this is a downward spiral that's not helping anyone."
With public debt at almost 70 percent of gross domestic product and one of the highest levels of private debt in the euro zone, Spain has been a focus of investors since Greece first appealed for international help in early 2010. The economy is more than twice the size of Ireland, Greece and Portugal combined, and is seen as too large for the euro zone to let it fail. Spanish government borrowing costs have fallen from 14-year highs reached last year but with economic fears resurfacing the risk premium over German bonds has started to rise again.
"If the government consistently runs large deficits in the midst of a very deep recession, or possibly both, then it's likely yields will rise," said Ben May of Capital Economics. "There is a risk that eventually Spain will need to seek a bailout to borrow at reasonable rates of interest."
Rajoy’s 2012 budget will include at least 35 billion euros of savings through tax hikes, wage reductions and public service cutbacks, in a bid to chop the deficit to the EU's 3 percent limit next year. The 2013 budget will be just as austere.
As in other European economies, domestic demand was one of the cornerstones of growth in the boom years but consumers are no longer seen as the economy's potential saviors. Celinda Garcia, 55, has run a delicatessen in a middle-class neighborhood of Madrid for 30 years and the four-year economic crisis had not affected her business until the most recent round of reforms and cuts. "I've really noticed a big drop in sales in the last couple of months," she says. "My customers mostly have secure jobs and a good income, but the latest reforms have left everyone worried for their future."
The economic troubles began over four years ago when a decade-long property bubble burst. The economy is expected to shrink 1.7 percent this year. Housing prices fell 11.2 percent in the fourth quarter of last year and may still have another 30 percent to go. The construction sector has hemorrhaged jobs, putting millions of low-skilled builders out of work.
Unemployment is more than double the European Union average, almost half of young people cannot find a job and poverty levels are rising faster than anywhere else in Europe.