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 Polls point to the country's first coalition government since
becoming a democracy 40 years ago, which could slow and dilute the
policy-making process even if market-friendly conservative prime
minister Mariano Rajoy is returned for a second term.
The vote comes just weeks after a Socialist government won power in
neighboring Portugal, toppling a short-lived center-right government
with the support of the far left and turning what first appeared as
an Oct. 4 election defeat into victory.
Spanish markets are relatively calm ahead of the vote.
Stocks may have underperformed their European peers this year and
bond yields and spreads have risen in recent months, but these moves
have been in the slipstream of broader market moves led by global
drivers like U.S. and euro zone monetary policy and the twists and
turns of China's economy and policy.
Spanish yields are still near record lows and the premium investors
demand for holding Spanish bonds over German debt is also low --
much of that is down to the crisis-averting actions of the European
Central Bank.
Investors say the key issue for the new government, whatever its
make-up, is the state of Madrid's fragile finances.
"Long-term debt sustainability remains a serious concern," Societe
Generale analysts wrote in a note this week.
"Given the limited fiscal space, there is a real risk that debt
could be pushed well above its already high level of 100 percent of
GDP. Any external shock could push debt much higher, above 130
percent."
Public debt to GDP ratio across the 19-nation euro zone bloc is
currently 92.5 percent.
Spain's net public debt is the highest it has ever been. Standard &
Poor's upgraded Spain's rating in October but warned that even
tighter fiscal policy will be required to keep that from rising and
to further reduce the budget deficit from just under 6 percent
currently.
The rating agency also cut the debt rating of Spain's northeastern
region of Catalonia, citing political tensions as Catalan
separatists push for independence form Madrid. Prime Minister Rajoy
has repeatedly vowed Spain will not break up.
FOLLOWING IRELAND?
The ruling People's Party leads the polls but looks set to fall
short of a majority, leaving the door open to potential pacts. The
main opposition Socialists (PSOE) and two newcomers, liberal
Ciudadanos and left-wing Podemos, are close behind.
Francois Savary, chief investment officer at investment firm Prime
Partners, summed up the view of many investors, saying his preferred
outcome would be for the PP to win outright or to form a coalition
with Ciudadanos to thwart the left-wing and anti-austerity party
Podemos.
"If Rajoy gets 30 percent, I could consider buying up Spanish
equities and bonds, as Rajoy has done well in terms of reforming the
economy," Savary said.
Rajoy won a convincing victory at the last election in November
2011, inflicting on the PSOE the worst defeat for a sitting
government since 1982.
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Then, the country was gripped by recession, stocks had just had
their worst quarter in almost a decade and bond yields and spreads
over benchmark Germany were the highest since the euro's launch. The
banking system was creaking and there were real fears that Spain
could crash out of the euro.
The backdrop to Sunday's election is less fraught. The economy is
recovering, unemployment is falling and financial market conditions,
by some measures at least, are the healthiest they've ever been.
Nobel Prize-winning economist Paul Krugman points to the collapse in
wages in Spain relative to Germany and the easing off of fiscal
tightening over the last couple of years as the two main drivers of
Spain's recovery.
But while the economy has grown every one of the last nine quarters,
economists argue that further reforms such as reducing public
spending and making labor markets more flexible are needed to keep
the recovery on track.
Structurally, the long-term growth outlook remains sluggish.
Economists at SocGen reckon Spain's potential growth level is around
1 percent absent further reforms.
"The policies of the next government could determine whether Spain's
growth prospects move closer to Ireland's or stay closer to its
Southern neighbors'," Barclays economists Apolline Menut and Antonio
Garcia Pascual said in a note on Tuesday.
Another once-troubled euro zone "peripheral" country, Ireland's
annual growth in the third quarter reached 7 percent.
Greece, Italy and Portugal, however, continue to struggle. Greece
came close to crashing out of the euro earlier this year and has
only just emerged from recession, Italy's economy is stagnating and
political crisis is bubbling just under the surface in Portugal.
Spain's economy is still around 5 percent smaller than it was in
2007, unemployment is over 20 percent and youth unemployment is
almost 50 percent. The scars of a lost decade, indeed a lost
generation, will be deep.
Analysts at Deutsche Bank are optimistic, however, predicting growth
of 2.7 percent next year, well above the euro zone average.
(Reporting by Jamie McGeever; Additional reporting by Sudip Kar-Gupta;
Editing by Sonya Hepinstall)
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