UPDATE 1-Spain launches budget clampdown, says regions on board

* Draft reform bill targets balanced budgets by 2020

* Debt, deficit levels to fall progressively

* Key region Catalonia says still studying draft

* Bill is first of trio of govt economic reforms

By Nigel Davies and John Stonestreet

MADRID, Jan 27 (Reuters) - Spain launched a budget clampdown on Friday, unveiling reforms that will usher in tougher oversight of public accounts and penalties for overspending that it said had won the support of the country's regions.

The draft law is the first in a trio of initiatives in coming weeks also covering the banking sector and the labour market as the government takes steps to nurse a recession-bound economy back to health.

The core targets announced in Friday's bill will see the public debt to GDP ratio progressively cut to 60 percent and the deficit to zero by 2020, figures that will apply to both central and regional accounts, Treasury Minister Cristobal Montoro told a news conference after a cabinet meeting.

"The reform is necessary to help to return to growth and create jobs as soon as possible, and steer the country out of crisis," Montoro said, adding that the regions had signed up to the pact.

But the regional administration in Catalonia - responsible for around a fifth of Spain's gross domestic product and one of four of the 17 regions not controlled by the centre-right PP party in government in Madrid - was still studying the draft, a spokeswoman said.

"This reform is important, but not sufficient on its own to regain market confidence, ... particularly of the bond market, if it does not generate expectations of growth," said Emilio Ontiveros, head of consultancy Analistas Financieros Internacionales.

In the past two years the regions, which overall account for around a half of public spending and control their own budgets for health and education, have missed their spending targets by a wide margin.

They likely ran a deficit at least double their target of 1.3 percent of GDP in 2011, according to government estimates. Full details of public accounts will be presented in March.

The overshoot - equivalent to around 15 billion euros - was a significant factor in Spain missing its overall deficit target for last year by around 2 percentage points.

As it tries to avoid being sucked deeper into the euro zone debt crisis, Spain is now hoping the European Commission will allow it to soften this year's overall target of 4.4 percent of output, taking into account a sharply deteriorating economic backdrop and surging joblessness.

LEEWAY DURING HARD TIMES

Under the bill, which lawmakers are expected to approve before the end of the first quarter, public administrations would have leeway to run deficits of up to 0.4 percent of economic output in exceptional circumstances, Treasury Minister Montoro said.

Overspenders would also have a year's grace to get their fiscal houses in order, though the government did not specify when the countdown would begin.

Regions that failed to meet that deadline would have to make a deposit equivalent to 0.2 percent of their nominal GDP, which would become a fine after six further months of non-compliance, Montoro said.

After nine months, central government would reserve the right to audit the affected region's accounts, though it did not intend to intervene in regional affairs and would act in accordance with European Union laws.

Montoro said the new laws would also establish an early warning system for monitoring deficit targets that might be missed, and regions facing cashflow problems would get help via additional credit lines.

"The aim of the new liquidity measures is to avoid the insolvency of any public administration," he said.

As well as bringing the regions into line, the government faces another potential fiscal stumbling block with its banking system, which is weighed down by a property market collapse four years ago.

Madrid has consistently denied public money will be used to shore up the banks, but its hopes of avoiding having to pump in billions of euros of state funds may be dashed because of the scale of the sector's problems.

The government is due to unveil its plans for overhauling the financial sector in mid-February.

It is likely to force lenders to price and provision for the billions of euros of foreclosed property and unrecoverable loans to bankrupt developers that are clogging up balance sheets, preventing the flow of credit.

"The (budget reform) goes in the right direction and will help restore confidence in Spain's economy. But the most important thing is the (upcoming) reform of the financial system," said Rafael Pampillon, a director at the Instituto de Empresas business school.

Madrid will also draft root-and-branch labour reforms in coming weeks to tackle the OECD's highest unemployment rate, which hit almost 23 percent at the end of last year.