Spain Faces EU Call for Deeper Deficit Cuts in Euro Rules Test

Bloomberg: European governments prodded Spain to make deeper budget cuts in a first test of stiffer deficit rules designed to prevent the region’s debt crisis from flaring back up.

Ten days after new Prime Minister Mariano Rajoy unilaterally raised the Spanish deficit target for this year, European finance chiefs called on Spain to prune an additional 0.5 percent of gross domestic product out of the 2012 budget.

Rajoy’s goal of a deficit of 5.8 percent of GDP in 2012 “is dead,” Luxembourg Prime Minister Jean-Claude Juncker told reporters late yesterday after chairing a meeting of euro finance ministers in Brussels. Spanish Economy Minister Luis de Guindos said that Spain remained “absolutely committed” to bringing the deficit within the euro area’s 3 percent limit in 2013.

That pledge is “far more important” Juncker said. “That is the main figure that should be kept in mind.”

European governments sought to show that tougher fiscal rules in effect since December have teeth, unlike the “stability pact” that let repeat violators of deficit limits go unpunished in the runup to the Greece-triggered debt crisis.

Spain would accept the EU’s “recommendation,” De Guindos said. “A lot of Spain’s considerations were taken into account, that last year’s deficit situation was much more complicated than what had been thought and that the situation is different from an economic point of view.”

Greece Aid

Pressure on Spain came as the ministers declared progress in fighting the two-year-old crisis, sealing a second, 130 billion-euro ($170 billion) aid program for Greece and pledging to boost the ceiling on overall rescue lending by the end of the month.

The euro traded at $1.3129 at 10 a.m. in Brussels, down 0.2percent from yesterday and the yield on Spain’s benchmark 10- year bond fell 2 basis points to 5.04 percent. Market stresses have eased as Greece avoided a disorderly default, the building blocks of a new euro economic-management system fell into place and the European Central Bank pumped over 1 trillion euros into the banking system in three-year loans.

Last night’s deficit deal was unexpected. European officials had planned to put off a reckoning with Spain until April, after the release of its 2012 budget and final EU data on the 2011 shortfall. Rajoy is set to present his spending plan and additional austerity measures on March 30, days after regional elections in Andalusia, a Socialist stronghold that his People’s Party is attempting to seize for the first time in three decades.

‘Sovereign Decision’

In office since December, Rajoy rattled Europe’s establishment after a March 2 leaders’ summit by shredding the original 2012 deficit target of 4.4 percent of GDP in what he called a “sovereign decision” for Spain alone.

Spain’s pleas didn’t go entirely unheeded. The euro ministers agreed that the initial 2012 goal is no longer reachable after Rajoy inherited a higher-than-expected shortfall last year from his Socialist predecessor.

“I don’t agree that Spain should go through excessive and stupid consolidation that puts it in a more difficult situation than it already is, but on the other hand Spain is the fourth- largest economy of the euro zone and as such it cannot take total leave from the promises it has made,” Juncker said. “Today’s result is a healthy mix between consolidation and common sense.”

Deficit Slippage

Spain’s deficit reached 8.5 percent of GDP last year, overshooting the 6 percent pledged by the outgoing government of Socialist Prime Minister Jose Luis Rodriguez Zapatero. Most of the slippage was due to bigger-than-forecast regional deficits.

The new government has already implemented 15 billion euros of austerity measures, including higher income-tax rates. The government forecasts the economy will contract 1.7 percent this year with unemployment holding above 24 percent, complicating efforts to raise revenue.

“Spain needs to do more and was called upon to do more,” Dutch Finance Minister Jan Kees de Jager said. “We have to keep on top of it, the pact has to be maintained, they have to implement the reforms and the austerity measures.”

Deficit concerns have led Spanish bonds to underperform those of Italy in recent weeks. Spain’s benchmark 10-year bond now yields almost 17 basis points more than the comparable Italian bond. A month ago the Italian 10-year yielded 30 basis points more than Spain.

Spain still faces an “enormous problem” to narrow the deficit to the 3 percent euro limit next year, said Luxembourg Finance Minister Luc Frieden.

“The 16 other finance ministers of the euro zone believe that what they have planned for this year is not yet enough,” Frieden said today in an interview on RTL Radio. “Spain has always been a country we kept an eye on.”

reporters on this story: James G. Neuger in Brussels