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C O N F I D E N T I A L SECTION 01 OF 02 MADRID 000654

SIPDIS

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E.O. 12958: DECL: 07/02/2019
TAGS: ECON EFIN ELAB PGOV SP
SUBJECT: UNEMPLOYMENT ZAPATERO'S MAJOR WORRY

REF: MADRID 613

MADRID 00000654 001.2 OF 002


Classified By: CdA Arnold A. Chacon, for Reason 1.5(D)

1.(C) Summary: President Zapatero's main worry at present is
Spain's faltering economy. The unemployment rate is over 18%
and is headed for 20%. The perception that the economy is
shedding jobs and that Zapatero does not know how to stop it
has begun to take a political toll on his administration. In
effect, jobs have become the line in the sand for this
President: if he cannot convince the public that the
unemployment news will improve in the medium term, his
political base will begin to erode at an ever-increasing
rate. The recession is expected to last longer than
elsewhere in Europe, and the ruling party has suffered at the
polls and in the legislature. The GOS has engaged in
aggressive fiscal stimulus but must soon cut spending and
increase taxes to head back towards the EU's deficit limit.
The banking sector has been relatively healthy so far, but
delinquency rates are rising and the GOS just established a
rescue fund to help it deal with an expected wave of troubled
institutions. The GOS does not face any more elections until
Catalonian regional elections late next year, and the
opposition's own problems have prevented it from taking more
advantage. Nonetheless, the economy is expected to make the
second half of 2010 uncomfortable for Zapatero and his
government. End Summary.

Unemployment Rising, GDP Falling
--------------------------------

2.(SBU) President Zapatero is facing sustained economic
difficulties made even more unpleasant by the contrast with
occasional encouraging signs in the U.S. and elsewhere in
Europe. The worst of his problems is the unemployment
rate, which at over 18% is the EU,s highest. The rate is
expected to top 20% later this year or early in 2010.
While Spain's unemployment benefits are more generous than
those in the U.S. and last for up to two years, benefits
for those who lost their jobs at the start of the slowdown
will soon begin to run out. Spain's troubles began before
those of much of Europe when its housing boom lost steam in
2007, and its recession is expected to last longer than
those in most of Europe. Many non-GOS observers do not
expect growth to resume until 2011.

Inaccurate Optimism and Political Consequences
--------------------------------------------- -

3.(C) Since the slowdown began, Zapatero and his
ministers (with the occasional exception of the
now-departed Pedro Solbes) have consistently put optimistic
spins on macroeconomic prospects. This tendency was most
pronounced in the runup to the March 2008 elections but has
continued since then, perhaps affected by Zapatero's
apparent focus on the importance of consumer and investor
confidence in sustaining economic activity. For almost two
years now, every GOS economic growth prediction has proven
overly optimistic and has soon been followed by less upbeat
predictions from outside analysts. While the crisis has
proven worse than almost anyone inside or outside
government had expected, press reports suggest that this
track record and Zapatero's continued expressions of
optimism may have hurt his credibility. The PSOE lost
seats in this month's European Parliament elections and
lost control of Galicia's regional government in April
elections. Even its good showing in the April Basque
regional elections has complicated matters. The Basque
chapters of the PSOE and the conservative opposition PP
formed a coalition to take control of the regional
government, the first time in the democratic era that the
Basque Nationalist Party (PNV) did not control the
government. In response, the PNV has stopped voting with
the PSOE in the national legislature, forcing the PSOE into
a difficult search for support from other small parties
each time it hopes to get legislation passed. Clearly
Zapatero realizes the political danger he is in. Every job
lost is another small nail in his coffin. When he met with
visiting Transportation Secretary LaHood in May, Zapatero
emphasized the importance of keeping open Opel's plant in
Zaragoza after the impending sale of Opel and asked the
Secretary for help conveying that message to GM. At some
point, Zapatero may face the unhappy prospect of ballooning
the budget deficit to extend unemployment benefits. It will
be a "damned if you do, damned if you don't" choice, since
the opposition parties will excoriate him either way.

MADRID 00000654 002.2 OF 002



Budget To Bring More Headaches
------------------------------
4.(SBU) When the economy began slowing in 2007, the GOS had
a relatively low debt-to-GDP ratio of below 40%. That gave
it room to respond with aggressive fiscal stimulus, through
increased spending and tax cuts (along with the automatic
stimuli of more unemployment benefit spending and lower tax
revenues). This year's deficit is expected to approach 10%
of GDP. However, the GOS will need to start to reduce its
deficit if it is to reach the EU limit of 3% by 2012. Even
if the GOS' growth predictions are accurate, it expects to
need to reduce nonfinancial spending by 4.5% in 2010, which
will force difficult and unpopular choices. On the revenue
side, the GOS earlier this month hiked cigarette and fuel
taxes and is said to face competing pressures from
different parties to raise either the value-added tax or
income taxes for 2010. To top it off, the GOS still has
not been able to reach agreement with regional governments
in a longrunning dispute over regional financing issues.

Worries over Banking Sector
---------------------------

5.(SBU) While conservative central bank regulation helped
Spanish banks avoid the financial turmoil that hit much of
the continent last year, the construction slump and overall
economic slowdown have boosted delinquency rates. Banks
and especially savings banks ("cajas") are expected to face
increasing difficulty over the next year as delinquency
rates continue to rise. The GOS last week established a
rescue fund to help it encourage mergers and intervene in
troubled institutions as needed (reftel). However, the
restructuring that is expected to result is likely to
eliminate tens of thousands of jobs in what is a relatively
overbanked country.

6.(C) Despite the gloomy outlook, Zapatero does have a
couple of things going for him. There are no national
elections until 2012 and no regional elections until
Catalonia's in late 2010. Also, the opposition PP has been
hurt by scandals and infighting and has not presented an
attractive alternative. Spain's EU presidency in the first
half of 2010 will give Zapatero a chance to be more of a
player on the international stage, but the economy is
likely to make for uncomfortable times between now and
then.

CHACON
CHACON