Spain: Another Election in Early 2016?

Do Spaniards want more reforms – or do they want to reverse some of the reforms that have helped to put the Spanish economy back on track? At the national election on Sunday, Spanish voters gave no clear answer.

Instead, uncertainty now reigns supreme in Madrid. Forming a new government will be tricky, finding a coalition that could last a full four-year term could be quite difficult indeed.

While much is at stake for Spain, the risk that any new government in Madrid could adopt policies that would jeopardize Spain’s place in the euro still looks small.

Roughly in line with the most recent opinion polls, Prime Minister Rajoy’s conservative Popular Party (around 29%) and the opposition Socialists (22%) lost as many votes as expected.

After a harsh adjustment crisis and allegations of sleaze against these two traditional parties that had dominated Spain for the last few decades, many voters turned to two upstart protest parties.

Projections

Between these two new parties, the radical left Podemos (21%) did slightly better and the liberal Ciudadanos (14%) fared slightly worse than expected. With 99% of the votes counted, projections give the Popular Party 122 out of 350 seats in the parliament with 91 seats for the Socialists, 69 for Podemos and 40 for Ciudadanos. The remainder goes to a panoply of regional parties.

A potential pro-reform alliance between the Popular Party and Ciudadanos with 162 seats would be far short of the 176 seats required for a majority. Until a late rebound of Podemos started two weeks ago, such an alliance had seemed to be the most likely election result.

On the other side of the political spectrum, a leftist anti-reform alliance between the Socialists and Podemos would also have just 160 seats and thus be unable to govern on its own. Because the left is more sympathetic to demands for more regional autonomy, the left may find it easier to strike deals with regional parties.

To complicate matters, Podemos is not exactly keen to support the traditional Socialists. And any potential partner for the Popular Party would likely demand that Rajoy is replaced by a new prime minister.

No option looks easy, to put it mildly. To form a government, potential coalition partners or potential supporters of any minority government would have to back away from things they proclaimed during the campaign. Take a look at some of the options:

The “grand coalition” option

The two big traditional parties, the Popular Party and Socialist, could form a German-style “grand coalition” with a clear majority of seats. But both parties have seen each other as their main adversary for so long that agreeing to such an alliance would require a big shift in attitudes.

It would make both of them vulnerable to lose more support to the new protest parties. By and large, such a grand coalition would probably soften some of the recent reforms at the edges and raise social spending without putting Spain’s strong economic rebound at risk. Given the circumstances, it would be a comparatively growth-friendly outcome.

The minority government option

The Socialists could try to form a minority government backed by the ultra-left Podemos. To enlist the needed support from Catalan left-wing and center-right pro-independence parties, they might promise Catalonia and possibly the Basque region a referendum on independence.

That would add a further element of uncertainty to the mix. Even worse, such a government would likely reverse many of the labor market and some of the other reforms of recent years that have underpinned Spain’s economic rebound since spring 2013.

Support against nationalists option

The Socialists may also try to garner support from both Podemos and Ciudadanos in order not to be beholden to Catalan nationalists. In such an alliance, Ciudadanos would probably prevent some of the reform reversals, which a leftist government may otherwise enact. But anti-reform Podemos and pro-reform Ciudadanos seem so far apart that such a government looks highly unlikely.

The new elections option

The Popular Party and Podemos may each conclude that they could do better in new elections. The Popular Party may see a new vote in early 2016 as an opportunity to present itself as a bulwark against instability and to campaign with a fresh new leader.

Podemos may believe that, after its late rebound in the opinion polls, it has momentum on its side. If both Popular Party and Podemos were to go for new elections, no government could be formed and new elections could loom in early 2016.

For Spain, a lot is at stake. Large-scale reform reversals would deal a serious blow to the longer-term outlook for the Spanish economy. But thanks to the adjustment progress of the last five years, the blow would not be fatal.

Having watched the sorry fate of Greece in 2015, even Podemos has become less radical. The risk that any new Spanish government could adopt policies that would jeopardize Spain’s place in the euro or trigger a new euro crisis still looks small.

In an unlikely worst-case scenario, an adverse market reaction to wholesale reform reversals would force any Spanish government to return to sensible policies. While the election result left many questions unanswered, it did not show any serious appetite among Spanish voters to leave the euro.

Some observers may proclaim that the election result signals an end to austerity in Spain. But that is not really new. Austerity ended in Spain in 2014 already as Spain had granted itself a pre-election fiscal stimulus this year.

Much more important than the fiscal stance is to what extent Spain preserves the pro-growth structural reforms it had courageously enacted under the Rajoy government.