Spaniards look poised to elect a new government with a clear mandate for change, at a time when political turmoil in Greece and Italy has brought a sharp escalation of Europe's debt crisis.
Sunday's elections bring the opportunity to shore up confidence in one of the euro zone's most indebted economies after the collapse of governments in Italy and Greece earlier this month spooked investors and sent borrowing costs soaring for even some of the highest-rated members of the common-currency area.
Investors are especially concerned about the ability of Italy to repay a debt load of €1.9 trillion ($2.6 trillion), nearly a quarter of all euro-zone debt.
A growing chorus of economists and euro-zone politicians are saying the only way to the stem the crisis is for the European Central Bank to aggressively ramp up its purchases of government debt.
On Thursday, the Spanish Treasury paid a 7% yield to sell a new 10-year government bond, a euro-era high. As it grapples with a burst housing bubble, a 21% unemployment rate and a budget deficit that stood at just over 9% of gross domestic product last year, Spain urgently needs to curb the rise of its financing costs as it completes the remaining 15% of its 2011 bond issuance and ahead of expected 2012 debt issuance of around €150 billion.
Largely thanks to spending cuts and economic overhauls pushed through last year by Socialist Prime Minister José Luis Rodríguez Zapatero, Spain has been able to finance itself at a lower cost than most of its fiscally frail peers. But the measures haven't made much of a dent in its problems, and its financing costs at this level are unsustainable in the long term. With evidence mounting that the economy could tip back into recession in the coming months and that the government will fail to meet this year's budget-deficit target, more-decisive steps are needed, analysts said.
Mr. Zapatero's failure on the economy has brought on the electoral collapse of his Socialist party, which polls forecast could suffer its worst-ever result in Sunday's election. Although Spanish elections have sometimes produced unexpected outcomes, Mariano Rajoy's Popular Party is expected to win a large parliamentary majority that would clear the way for the conservative leader's program of austerity and economic overhauls.
Still, "the lack of positive market responses to the prospect of a reform-oriented government means that the crisis is already much bigger than the member states of the euro zone," said Antonio Barroso, a London-based analyst for political consulting firm Eurasia. "It is a reminder not only that a European Union-comprehensive solution is needed, but also that European democracies are currently ill-equipped to deal only by themselves with the frantic pace of the sovereign crisis."
Although he lacked a parliamentary majority, Mr. Zapatero was able to deliver all the measures he promised last year, including a public-sector wage cut, a labor-market overhaul that lowered the country's high cost of dismissal and a pensions overhaul that will move back its statutory retirement age to 67 from 65. Still, the Socialist premier has been a half-hearted reformer, publicly acknowledging he would have never have taken the measures he did in the absence of tremendous outside pressure.
Mr. Rajoy, on the other hand, presents himself as a true believer in the merits of austerity and has promised a series of new measures in the "first 100 days," if elected, to ensure the country meets budget targets agreed with the European Union and returns the economic growth. Although the conservative leader hasn't given much detail on his plans, analysts said his party's economic pedigree lends him credibility. The Popular Party-led governments of José María Aznar from 1996-2004 are remembered for far-reaching overhauls that helped set the stage for a lengthy economic boom. Mr. Rajoy headed various ministries during that time.
Analysts say that, even if Mr. Rajoy falls short of a majority, he could likely rely on the support of Catalan and Basque regional parties, whose views on economic policy are closely aligned with his own.
"Of course, a new Popular Party government will be better but will not be enough if the overall European Union issue is not addressed," said Angel de la Fuente, head of Kepler Capital Markets in North America. "The markets are already discounting the Popular government. If not, Spain would be in a much worse situation, similar to Italy."
According to data from PriceWaterhouseCoopers, in addition to the government's financing needs of around €150 billion next year, Spanish banks will have to raise around €120 billion—three times more than in 2011—while nonfinancial corporations will have to raise about €30 billion. Most Spanish banks have had serious difficulties issuing debt this year and have come to rely on the emergency liquidity facilities of the European Central Bank.
Key to shoring up investor confidence will be redoubling efforts to slash Spain's large budget deficit at a time when the country's timid, export-driven growth spurtis showing signs of petering out. Spain is widely expected to surpass this year's 6%-of-GDP deficit target, making it much more difficult to meet next year's 4.4%-of-GDP target. Analysts say a series of emergency budget cuts for 2012 will have to be one of the new government's first orders of business when it takes over near the end of December.
Just as important as budget cuts is convincing investors that Spain has a growth strategy, said Luis de Guindos, head of Financial Center, a banking industry think tank. "The challenge in getting markets to open up again is to generate the expectation that the economy return to growth," said Mr. de Guindos, whose name has been raised in Spanish political circles as a possible finance minister to Mr. Rajoy if he wins. Mr. Rajoy hasn't said who would fill his top cabinet posts.
To stimulate job creation and economic growth, the Popular Party has promised to overhaul labor laws to, among other things, allow companies to more easily adapt national or sector-wide wage deals with unions to their own needs. It also wants to accelerate the cleanup of a banking sector laboring under a load of around €180 billion of souring real-estate assets.
Unions are likely to bitterly contest further labor-market overhauls. Last year, they held a general strike and staged multiple demonstrations against changes and budget cuts.
Although organized labor isn't the force it once was in Spain, a more-potent protest movement emerged just prior to regional elections in May, when tens of thousands of demonstrators gathered in town squares across the country. Similar to "Occupy Wall Street" in the U.S., Spain's 15-M is calling for political overhauls and an expansion of social-welfare programs. The movement named after its May 15 launch date is gearing up for a large demonstration on Sunday.
On the sidelines of a 15-M meeting in downtown Madrid, José Miguel de Vicente, a 68-year-old retired engineer, said he forecasts rising tensions if an incoming Popular Party-led government makes deep budget cuts. "There will be more and more protests, and the Popular Party will try to crack down on them, but they will continue," he said.
PP officials insist they won't blink in the face of social protest if they win an electoral mandate for change. Political analysts say there is evidence that Spaniards generally believe that more sacrifices will required of them to solve the country's problems.
Félix Munilla, a 42-year-old accountant in Madrid, said he plans to vote for one of the country's small left-wing parties, but that he understands the need for changes in, for example, Spanish labor laws. He said people in pro-euro Spain have been spooked by recent events in Greece and Italy, which have fanned fears of a single-currency breakup.
"I got up one morning last week and the radio was saying, 'Gentlemen, [the euro] is all over.'…My heart skipped a beat," he said.
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