Spain’s Economy Slips, Threatens Further Euro-Zone Contamination

Spain is unlikely to meet its deficit-reduction target for this year as economic growth slows, putting the euro zone’s fourth-largest economy in danger of a full-scale debt crisis that threatens to further contaminate the region as European leaders continue to stumble in efforts to construct a fail-proof safety net.

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“They will never make it,” said Ludovic Subran, chief economist at credit insurer Euler Hermes SA in Paris. “Our September forecast sees Spain’s deficit at 7 percent” of gross domestic product this year. Subran added that the prediction was made before the Spain’s credit rating was cut earlier this month.

Spain was aiming for a deficit equal to 6% of GDP this year, down from 9.2% in 2010. Sometime this week, data on the deficit for the first nine months of 2011 will be released.

During a summit in Brussels over the weekend, European leaders ruled out tapping the European Central Bank to fund the region’s rescue facility. Their failure to enact any measures that would end the debt crisis risks “a vicious circle” in which “deficit reduction weighs on growth, rendering targets unachievable and triggering more downgrades, eventually leading” to default, said Angel Laborda, chief economist at savings bank foundation Funcas in Madrid, who added that policy makers must find a way to repay euro-zone nations’ debt even without economic growth.

Over the weekend, France’s efforts to enable the European Financial Stability Facility to borrow potentially limitless sums from the ECB were quashed by Germany. Some policy makers hope to use the 440 billion-euro EFSF to guarantee government-bond sales, while others want to set up an EFSF-insured fund that would seek outside investment. No decision has yet been made as to which approach, if either, to take, but leaders meet again at a summit tomorrow.

“There is insufficient firepower to meet all the potential liquidity needs,” said David Mackie, chief European economist at JPMorgan Chase & Co., in an October 18 note to investors.

Spain has the region’s highest jobless rate, with roughly 21% of eligible workers unemployed. It’s economy slowed in the second quarter, expanding just 0.2% after expanding 0.4% in the first three months of 2011. Prime Minister Jose Luis Rodriguez Zapatero says quarterly growth will likely remain at levels similar to the April-June period for the rest of 2011.

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Though the European Union said yesterday that Spain is on track to meet its deficit goal for 2011, economists have revised their forecasts to reflect dwindling tax revenue, rising borrowing costs, and fiscal slippage in the nation’s social-security system and the semi-autonomous regions.

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