Spain Says its Regions Are Financially Sound

By THOMAS CATAN And JONATHAN HOUSE

MADRID—Spain said its regional governments are on track to meet their budget targets this year, its latest effort to quell investor fears that it could be the next European country to need a financial bailout.

Facing intense market pressure, Spain for the first time opened its regions' books before year-end in a bid to address investor worries that the regions' deteriorating accounts could derail the government's austerity drive. The early peek showed regional spending to be largely under control, though some analysts cautioned that the biggest test of their finances still lies ahead.

The average deficit across the 17 regions was 1.24% of gross domestic product at the close of the third quarter, the Finance Ministry said—comfortably within the 2.4% target for the full year. Two regions have breached their deficit ceiling: Murcia and Castilla-La Mancha. But the two are relatively small regions, jointly accounting for about 6% of the national economy.

The figures show "substantial progress" is being made at the regional as well as the central-government level, said Andrés Fuentes, an economist at the Paris-based Organization for Economic Cooperation and Development. "I think the country is on course to achieve its budgetary target this year and also next year."

But some said that Spain wasn't out of the woods yet. The biggest spending items usually appear in the final quarter of the year, and tax revenues could drop further, imperiling the country's budget numbers.

Spain's property prices are still falling after the bursting of a 15-year, credit-fueled property boom, and banks are facing growing bad debts. That, some fear, could force the government to aid the banks and hurt its own finances.

"This is somewhat reassuring, but it's unclear what lies under the hood of some of the banks," said Nicholas Spiro, a London-based sovereign-risk strategist.

To reassure investors on that front, Spain's central bank is bringing forward plans to open the books of regional savings banks, which were most exposed to the country's property bubble and are closely tied to regional governments. Spain's regions are central to the government's efforts to slash its budget deficit. While it isn't officially a federal country, Spain has one of the most devolved power structures in Europe. Its regions have broad autonomy and provide basic services such as health care and education.

Regional governments and town halls now account for around half all public spending in Spain, compared with just over 20% for the central government. Social-security spending accounts for the remainder.

Moody's Investors Service, the ratings agency, said last month that Spain's regions would find it "very challenging" to meet their budget targets for this year and next. It declined to comment Monday on the latest regional deficit figures.

Spanish regions have been largely shut out from international credit markets for much of the year as a debt crisis roiled the 16-nation bloc that uses the euro as currency. That has forced many to turn to more expensive and short-term funding that could make their finances worse.

Catalonia, Spain's most economically powerful region, was recently forced to raise money from its own residents through "patriotic bonds." Other regions, such as Valencia, are following its example.

Such local retail bonds have significant drawbacks, however. They are an expensive and short-term way for regions to fund themselves and compete with banks for residents' savings. That could end up hurting banks' efforts to rebuild their financial strength.

Investors fear that in a worst-case scenario the central government might have to bail out regional and municipal governments. Moody's, for example, said the central government has "very powerful incentives" to support the regions should they find themselves shut out of public and banking markets for an extended time.

Some also fear that political considerations will limit how much pressure the government can exert on spendthrift regions. The ruling Socialist Party depends on the support of regional parties because it lacks an overall majority in Congress.

Next year, it says, regional governments will have to refinance about €30 billion in debt.

So far, however, the central government is standing firm. Prime Minister José Luis Rodríguez Zapatero recently refused a request by the nation's debt-laden capital, Madrid, to refinance part of its €7.2 billion debt pile.

Madrid's mayor, Alberto Ruiz-Gallardón, embodies the free-spending spirit that took hold of many cities and regions during the economic boom. Under his direction, the city embarked on a series of massive public works, bringing in two of the world's largest tunnelling machines and naming them after characters from Spanish history and literature.

Mr. Gallardón, who has long harbored prime ministerial ambitions and was often depicted as an Egyptian pharaoh in newspaper caricatures, had most of the capital's ring road buried underground at a cost of €4 billion.

Spain received some qualified support Monday for its efforts to shore up its ailing economy. In its annual report on the Spanish economy, the OECD said Spain's budget-deficit reduction plan "seems appropriate" but urged the country to push forward with an overhaul of rules governing regional-government spending and of its banking sector and labor laws. (Fonte: Wall Street Journal)