Spain's new government said today the public deficit for 2011 would come in at 8 per cent of gross domestic product, well above a target of 6 per cent, and announced income and property tax hikes and a civil servant wage
freeze in response.
Spain has been under market scrutiny about its ability to control public finances, and Madrid has seen risk premiums soar to record highs on contagion fears as the euro zone debt crisis has spread.
Deputy prime minister Soraya Saenz de Santamaria in the new centre-right government outlined public spending cuts worth €8.9 billion to tackle the deficit.
"We're facing an extraordinary and unexpected situation, forcing us to take extraordinary and unexpected measures," Ms Santamaria said.
While Italy debt mountain has been the biggest concern in financial markets in recent months, Spain had been seen as faring somewhat better, although it too has been hit with high borrowing costs.
The previous socialist government cut the budget shortfall from 11.2 per cent of gross domestic product in 2009, and the conservatives must take up the baton and bring the deficit down to 4.4 per cent in 2012 and 3 per cent in 2013.
The conservatives, who swept to victory in November amid dissatisfaction over the socialists' handling of the crisis, have pledged to turn the economy around while reforming a broken labour market and pulling the country out of a prolonged slump.
New treasury minister Cristobal Montoro announced tax hikes today that will focus on the wealthy, raising around €6 billion.
Prime minister Mariano Rajoy has pledged to turn the battered economy around by meeting tough budget deficit reduction targets while reforming a broken labour market and pulling the country out of a prolonged slump.
But since he has had only a week to view the books left by the socialists and the 2012 budget has still to be decided, the measures announced after the weekly cabinet meeting will be just the start with lots of pain further down the road.
Mr Rajoy told parliament last week that he would decree today an extension of the 2011 budget until March 31st and pass emergency spending cuts for the first quarter. He also said the 2012 spending ceiling would be set later in January.
The prime minister said the only spending increase would be an inflation-linked state pension hike.
The government may also reveal today some details of a law, that will not be passed until January, to implement an earlier constitutional amendment on fiscal discipline.
Mr Rajoy is faced with a difficult balancing act, but has a strong mandate with a parliamentary majority.
On the one hand he needs to reduce the deficit through dramatic spending cuts, but on the other he must increase competitiveness and restart a stalled economy. He has already proposed some tax breaks for companies.
Spanish wages have risen sharply in the last few years - by 20.8 per cent in 2003-2008 compared to just 9.7 per cent in Germany according to data from the IESE business school - stripping the workforce of its competitive edge.
The collapse of the property market after the 2007 global credit crunch and shrinking consumer confidence have hit the economic cornerstones of construction and services, leaving Spain struggling to grow since emerging from recession in 2010.
Economy minister Luis de Guindos said this week he expected a weak start to 2012 and many economists believe Spain has already entered a recession which could drag on for several quarters.
Meanwhile, a perceived failure by European leaders to create a credible backstop against the euro zone debt crisis has put peripheral economies like Spain in the limelight and means Mr Rajoy will need to show he has a tight hold on the economy's reins.
Spain has no major debt redemptions before April, giving Mr Rajoy some room to manoeuvre while Italy remains at the sharp end of investor worries with 10-year benchmark bond yields still precariously near 7 per cent at Rome's closely-watched auction yesterday.
However, Spain's own financing costs remain high and market confidence will plummet if the conservatives waver.
Many Spaniards are ready for further cuts, with some 49 per cent understanding more sacrifices must be made to emerge from the crisis, according to a survey published recently in El País newspaper.
"Most Spaniards know things are going to get tough, and so there's no reason to pull any punches. I think Rajoy is focused on Spain as a whole, implementing his programme and doing that in an effective way, and that may mean some moderation on the cuts, but that doesn't mean sugar-coating," said David Bach, political analyst at IE business school in Madrid.
Reuters