MADRID—Spain’s economy is in recession and facing an “exceptional” situation, its central bank governor warned on Tuesday, as Madrid’s borrowing costs nearly doubled from a month ago and the International Monetary Fund called on Madrid to review the pace of fiscal adjustment.
Speaking before a parliamentary committee, Bank of Spain Gov. Miguel Ángel Fernández Ordóñez said the euro zone’s fourth-largest economy was “back in recession” after a mild recovery in early 2011, “with only exports as a positive contributor to gross domestic product.”
Mr. Fernández Ordóñez defended the government’s austerity program, saying that cuts to unproductive government spending shouldn’t have a negative effect on growth and that the alternative would be worse for Spain.
“Many people think that austerity is going to make the economic situation worse, but we think it’s going make it better,” Mr. Fernández Ordóñez said. “We think that things will get much worse if Spain doesn’t reach the budget deficit targets.”
At the same time, Mr. Fernández Ordóñez said Spain’s banking sector may face further difficulties if the economy contracts much more than expected, along the lines of the most pessimistic private-sector forecasts. He also said he doesn’t think Spanish banks will need European Union help to recapitalize themselves.
EU policy makers on Tuesday reiterated recent statements of support for Spain’s efforts to rein in its debt and deficit, helping Spanish bonds rally from recent lows even as investors demanded significantly higher yields to buy Spanish Treasury bills offered in auction.
Overall, the Treasury sold €3.178 billion ($4.18 billion) of 12- and 18-month bills, above the upper end of the €2 billion to €3 billion target range. The average yield on the 12-month T-bills came in at 2.623%, up from 1.418% at the previous auction, on March 20. The average yield on the 18-month T-bills came in at 3.11%, up from 1.711%.
Job seekers await the opening of an employment center in Madrid this month. The Bank of Spain on Tuesday defended the nation’s austerity measures.
Analysts said the fact that Spain completed the auction with healthy demand levels is a relative success, and that pushed up stock prices on both sides of the Atlantic. However, the rising borrowing costs also underline the credibility problems faced by the country’s new conservative government—in power since late December—as it embarks on an unprecedented two-year austerity drive that seeks to cut the government budget deficit from 8.5% of gross domestic product last year to 3% of GDP in 2013, as requested by EU partners.
In addition, analysts said the rise in yields bodes ill for Spain’s more significant auction of two- and 10-year government bonds on Thursday. Treasury-bill sales are dominated by domestic investors. Sales of longer-dated bonds, in which foreign investors tend to be more active, are seen as a more accurate gauge of investor sentiment.
Under Prime Minister Mariano Rajoy, a firm defender of the austerity policies championed by Germany’s Chancellor Angela Merkel, Spain is implementing cuts across all levels of government and has reversed course on a 30-year process of power devolution to regions.
A senior government official said Tuesday that the government stands ready to intervene in regional governments—a move made possible by a new law empowering Madrid’s central government—as early as May, amid investor and government doubts that the cash-strapped regions can reduce their deficits quickly enough to comply with Spain’s commitments.
Still, many doubt Madrid can reach ambitious deficit targets in the middle of a deep economic crisis. Spain’s government anticipates that GDP may contract 1.7% this year, and the IMF on Tuesday reviewed its forecast to call for a contraction of 1.8%, from a previous forecast of 1.7%, citing the effect of austerity cuts.
The IMF also made a bold call for less austerity in Germany, and said that Spain’s new government may also have erred on the side of cutting too much too fast.
Spain’s new deficit target “could have accommodated more fully the impact of the weak growth outlook,” the IMF said—echoing the view of the Spanish government, which battled even more austerity-minded EU partners to slow the pace of cuts this year and was only partially successful.
The Spanish government finds itself facing a paradox now familiar to euro-zone members. Investors are demanding action to cut the budget deficit, but the spending cuts and tax hikes needed to do that will likely lower government demand for goods and services. At the same time, the private sector is deleveraging after the boom years leading to 2008, making it more difficult to cut the budget deficit as the process lowers tax revenue.
“The recent volatility in Spanish yields stems from the fact that the Rajoy government is in ‘damned if it does and damned if it doesn’t’ situation,” said Nicholas Spiro, managing director at Spiro Sovereign Strategy. “While Spain urgently needs to get a grip on its finances, nonstop austerity risks throttling the economy.”
Jean-Claude Juncker, the influential head of the Eurogroup of euro-zone finance ministers, said Spain doesn’t need financial support from EU partners.
Mr. Juncker, among the most prominent critics of Spain’s attempts to slow the pace of deficit narrowing earlier this year, said markets should “take note” of the “ambitious efforts” made by Madrid to get its finances in order.
“I invite markets to be more rational…Spain is on track,” he said, saying the country should be commended for the way it has sought to rein in its public deficit and
—Vanessa Mock in Brussels contributed to this article.
Write to Emese Bartha at emese.bartha