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Spain: Government presents austerity budget and new reform plans

September 28, 2012

On 27 September, the government presented its budget for the year 2013. The budget represents the fifth austerity package since Mariano Rajoy assumed power in November last year and seeks to cut the overall fiscal deficit to 4.5% of GDP in 2013 from the 6.3% of GDP shortfall expected this year. The adjustment forms part of the Spanish government's commitment to reduce the fiscal gap to below 3.0% of GDP by 2014, as previously agreed with the European Commission. However, only two days after presenting the document, Economy Minister Cristobal Montoro announced that, when computing public aid to banks, the fiscal gap will reach 7.4% of GDP this year, while revising the fiscal deficit figures for 2011 from the previous 8.9% of GDP to 9.4% of GDP. Montoro, however, explained that the official target of 6.3% is still valid as the cost of the bank rescue can be excluded. In order to consolidate the budget, the government announced a EUR 13 billion adjustment of tax increases and spending cuts. The Rajoy administration will cut ministries' spending by 8.9%, mostly by freezing wages for civil servants for a third consecutive year. Despite the spending cuts, overall spending will actually increase by 5.6% as a result of a sharp rise in debt-servicing costs, which will jump by 34%. Basic social expenditures such as unemployment benefits will not be cut and retirement pensions will, in fact, be increased by 1%, which will partly be funded by using EUR 3 billion from the country's pension reserve fund. On the revenue side, the government announced a series of tax increases that are expected to bring in an additional EUR 4.4 billion in revenues. These measures come on top of the hike in the Value Added Tax which took effect on 1 September 2012, a measure that should provide an additional EUR 10 billion to government coffers in 2013. Simultaneously, the government announced a series of structural reforms, most notably the creation of an independent fiscal authority. The establishment of an independent fiscal authority responds to demands from the European Commission and aims to oversee the execution of the adjustment process. In addition, the Rajoy administration announced that it would introduce 43 new laws to reform the economy over the next six months that include the liberalization of the labour market, as well as the telecommunications and energy sectors. Despite the government's firm commitment to fiscal consolidation, markets expect that the country will not be able to meet its fiscal goals either this year or the next. Analysts consider the growth assumptions underlying the budget as overly optimistic. According to the draft, the government projects the economy to contract 0.5% in 2013, well above the 1.5% decline expected in this month's Consensus Forecast. Meanwhile, on 28 September, consulting firm Oliver Wyman presented the long anticipated results of the "bottom-up" evaluation of the country's banking system. According to the examination, Spanish banks would need as much as EUR 59.3 billion in additional capital under the most adverse scenario considered. The figures are broadly in line with the results of the stress tests previously published in June and well below the EUR 100 billion rescue package agreed with European authorities. Following the announcement, government officials stated that the country may need to use between EUR 30 and EUR 40 billion in European funds in order to recapitalize its banking system. After presenting the budget and reform plans, bond yields dropped slightly by 3 basis points. However, at 5.9% on 1 October, they remain high and hover around a level that many analysts consider unsustainable. In part, the high bond yields reflect growing political tensions that have been manifested in a wave of protests against social cutbacks and a rising secessionist movement in Catalonia, the country's largest regional economy. On 25 September, Prime Minister Rajoy stressed that he would seek a bailout if bond yields for Spain became "too high". A majority of analysts expect that Spain will request a full bailout programme in the coming months as financing costs are becoming an unsustainably burden, given the dismal economic outlook.


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