European leaders are testing the latest version of their debt crisis strategy in Spain, granting Prime Minister Mariano Rajoy more time to reduce the budget deficit in exchange for deeper spending cuts.

Rajoy yesterday announced 65 billion euros ($80 billion) of austerity measures in a renewed effort to meet European Union budget targets after he was granted a one-year extension on the deadline to meet EU limits.

“Europeans are learning from past mistakes,” said Christian Schultz, a senior economist at Berenberg Bank in London and a former European Central Bank official. “The stick is necessary but the carrot is also good.”

Europe's concession to recession-wracked Spain has raised expectations in Ireland and Portugal that they can win more time to rein in their budget deficits after Germany's hardball tactics in Greece spurred a rebellion against bailout politics there.

Spanish bonds rose for a third day today. The extra yield investors demand to hold Spanish 10-year debt instead of the benchmark German bunds dropped 4 basis points to 527 basis points at 11:15 a.m. in Madrid.

“People can see that they are serious,” said Javier Morillas, professor of international economics at San Pablo CEU University in Madrid. “I don't think these are the last measures we'll see, and they certainly aren't the last cartridges Rajoy has left.”

Rajoy's budget package came as Spain finalizes the conditions of a 100 billion-euro bank rescue bank that will allow International Monetary Fund officials to intervene in the process of restructuring the banking system and tightens scrutiny over spending plans.

European leaders also held out the prospect of buying Spanish debt to trim yields as long as Rajoy complies with their conditions, which include transferring powers from the Economy Ministry to the Bank of Spain and bolstering the central bank's independence.

Rajoy is also seeking additional cuts from the 17 regional governments, which control health and education. Even as Spain's own access to capital markets is narrowing, the central government is planning to help states fund themselves on markets. Budget Minister Cristobal Montoro meets regional finance chiefs today at 4 p.m. in Madrid to discuss the plan.

Pay cuts and holiday restrictions for public workers will save 6.3 billion euros a year, Deputy Budget Minister Antonio Beteta said yesterday.

Greek Recession

With the extra year, Spain has until 2014 to bring its deficit within the EU's 3 percent limit. European finance ministers agreed to loosen the 2012 deficit goal to 6.3 percent of GDP from 5.3 percent. Still, ministers urged Spain to step up budget cuts.

Even after the concessions on the timing, Europe's demands may end up pushing Spain deeper into recession like Greece, which has been in recession since 2008. The Spanish program brings the fiscal tightening for this year to about 65 billion euros, Schultz estimates, after three previous packages.

“Just when you think reason and pragmatism are returning, European policymakers resort to type,” said Dario Perkins, an economist at Lombard Street Research Ltd. in London, in research note. “Significant fiscal tightening was the last thing the economy needed.”

Rajoy is already facing a backlash from Spanish voters with unemployment at 25 percent and the economy sliding deeper into its second recession since 2009. Miners who've been striking for the past seven weeks clashed with police outside the industry ministry in Madrid yesterday as they demanded the government reinstate subsidies they say are needed to keep their industry alive.

Spain's two largest unions, Comisiones Obreras and Union General de Trabajadores, called a day of demonstrations for July 19 to protest, saying the cuts target the poor and the middle class without affecting companies or the wealthy.

The premier also scrapped a mortgage rebate, reversing a policy he implemented in December at his second Cabinet meeting to enact an election promise. At the same time, he had raised pensions to meet another pledge. Yesterday, he said he'd present parliament's pension committee with a bill to make retirement benefits more sustainable.

Even with the new targets, Spain needs to cut the deficit by 2.6 percent of GDP as the economy shrinks. The deficit overshot last year as the economic downturn bit into tax revenue and regions unearthed undeclared bills. The government forecasts a contraction of 1.7 percent this year and Rajoy said today the slump would continue next year.

“We have very little room to choose,” Rajoy told the national parliament in Madrid. “I pledged to cut taxes and now I'm raising them. But the circumstances have changed and I have to adapt to them.”

Bloomberg News

Instant Insights /

EU Tries New Model in Spain

Related Stories

Recommended For You