Deflation raises the size of your debt,...It’s hard to think of a worse combination of factors than you’ve got here

TO BE NOTED: From Bloomberg:

"Spanish Slump Stokes Debt Dilemma as Jobless Rises (Update2)

By Emma Ross-Thomas

June 3 (Bloomberg) -- Spanish workers are finding that the cure for a decade-long borrowing binge may just make things worse.

As Spain sinks deeper into recession and the jobless rate heads for 20 percent, the highest in Europe, employers are telling workers to accept wage cuts if they want to stay competitive. That’s making it harder for households to tackle a debt load built up during the country’s economic boom and equivalent to 18,000 euros ($25,700) per person.

“There’s a Catch-22 problem for Spain,” said Dominic Bryant, an economist at BNP Paribas SA in London, referring to the 1961 novel by Joseph Heller that highlights a no-win situation faced by a World War II pilot trying to avoid duty. “The solution for the competitiveness problem makes their debt problem worse. By squeezing wages you weaken the domestic economy further.”

Annual growth of almost 4 percent over a decade turned Spain into an engine of Europe’s economy, boosting pay and prices as a building boom encouraged households to rack up 800 billion euros in debt. More than a year into a housing slump that helped spark the worst recession in six decades, the challenge is to trim labor costs and pay back loans without hobbling the country’s route to recovery.

For Patricio Zuniga, a 40 year-old builder in Madrid, that’s looking difficult after a 50 percent wage cut since the peak of the boom in 2007.

Burden

“We only just make it to the end of the month and we’ve already run through our savings,” said Zuniga, whose mortgage burden is now 80 percent of his family’s income. “They say: ‘If you like it you can take it and if not, well, that’s it.’”

BNP’s Bryant doesn’t expect domestic demand to grow until the second half of 2011.

At 70 percent of gross domestic product last year, Spain’s mortgage and consumer credit burden is the largest of the euro region’s major economies and compares with 45 percent for the bloc as a whole, European Central Bank data shows.

Spain is also one of the countries threatened most by deflation. Consumer prices fell annually in March for the first time since 1952 and dropped 0.8 percent in May. The rate for the bloc as a whole was zero.

“Deflation raises the size of your debt,” said Gayle Allard, vice rector at Madrid’s Instituto de Empresa business school. “It’s hard to think of a worse combination of factors than you’ve got here.”

Pay

While influential unions are still managing to win pay raises, that may change as unemployment surges. Companies’ wages grew 3.5 percent in March on the year. In the same month, workers at Seat, a unit of Volkswagen AG, agreed to a salary freeze to convince management to manufacture its Q3 vehicle in Spain.

ArcelorMittal, the world’s largest steelmaker, will temporarily lay off 11,964 workers in Spain until the end of the year, the MCA-UGT union said today.

“When the downturn starts to affect those represented by the unions, that’s when they tend to become more sensitive to what’s going on in the economy,” said Gregorio Izquierdo, head of research at Madrid’s Institute of Economic Studies.

Temporary workers are already seeing pay cuts. At 29 percent, Spain had twice as much temporary employment as the average in the 27-member European Union last year and the highest in the bloc, according to the EU’s statistics office.

Worried

For many workers, lower wages are wiping out the benefits of the ECB’s interest-rate cuts since the economic crisis intensified last year.

“You can imagine how worried I am,” said Pedro Sanchez Abellan, 30, in Madrid. He took a 25 percent salary reduction this year in a temporary job installing security systems, to earn 900 euros per month, making it harder to pay off a 3,000- euro loan.

Spain’s slump has seen a series of companies including property developer Martinsa-Fadesa SA shed workers as they seek protection from creditors.

Shares have dropped. Second-largest lender Banco Bilbao Vizcaya Argentaria SA and third-largest builder Fomento de Construcciones & Contratas SA have both fallen more than 40 percent since the end of 2007. Spain’s services industry contracted more sharply in May than the previous month, as an index based on a survey of purchasing managers by Markit Economics fell to 39.1 from 42.3 in April.

Squeeze

Falling wages would squeeze public finances. With the European Commission forecasting a deficit at 9 percent of GDP this year, investors are charging more to hold Spanish debt. The extra interest demanded over German bunds is more than triple what it was last year.

“If there’s negative wage growth, that implies income tax receipts are going to be falling, and so other things being equal it becomes more costly to repay its existing debt,” said Ben May, an economist at Capital Economics in London.

One of Spain’s most pressing problems is that it has become less competitive since the euro was created in 1999, with Commerzbank AG estimating based on labor costs that it has become 10 percent more expensive relative to the rest of the currency bloc.

“The only way for Spain to recover the lost competitiveness of the last 10 years will be for a sustained drop in prices and wages,” said Luis Garicano, a professor at the London School of Economics.

That means debt burdens will keep rising for workers such as Zuniga, the builder. His 1,680-euro monthly mortgage payment eats up most of the combined 2,000 euros he and his wife earn.

“The mortgage is only three years old, we’ve got 30 years left to go,” he said.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net"