WRAPUP 1-Spain and France raise budget flags, Greek talks stall
* Commission forecasts see Spain far wide of deficit goals
* France also raises concerns, with deficit above target in 2013
* Greek political parties fail to reach coalition agreement
* Banks quietly preparing for return of Greek drachma
By Luke Baker and Lefteris Papadimas
BRUSSELS/ATHENS, May 11 (Reuters) - Spain and France came under intense pressure from the European Commission on Friday to take bolder steps to cut their budget deficits as Greece's political impasse deepened, highlighting the range of problems facing the troubled euro zone.
Presenting its twice-yearly economic forecasts, the European Commission said Spain would run a deficit of 6.4 percent of economic output this year and 6.3 percent next year, with both targets substantially above levels already agreed with the EU.
France, the euro zone's second largest economy, will also miss its 2013 budget deficit goal of 3 percent by a wide margin, the Commission said, meaning new President Francois Hollande will have to take swift action to cut spending and raise taxes.
Hollande said he had been aware for several weeks of a bigger deterioration in public finances than the outgoing government had admitted, and would await an audit by France's budget watchdog before "taking the necessary decisions".
Olli Rehn, the European commissioner for economic affairs, said he had full confidence in Spain's ability to meet its targets, but with the economy expected to contract this year and next - the worst outlook in the euro zone - and the country's banks being rescued at high cost, Madrid has its work cut out.
"This calls for a very firm grip to curb the excessive spending of regional governments," Rehn said at a news conference to present the macroeconomic forecasts for the EU's 27 countries, including the 17 that share the euro.
"For Spain, the key to restoring confidence and growth is to tackle the immediate fiscal and financial challenges with full determination," he said.
In Greece, the leader of the moderate Democratic Left party appeared to dash hopes for the formation of a coalition government following Sunday's inconclusive elections, saying he would not back any coalition that supports the 130-billion-euro EU/IMF bailout keeping Greece afloat.
That raises the likelihood of having to hold a new general election, probably on June 17. But there is no guarantee a second poll will produce a result with better prospects for forming the pro-bailout government that EU leaders want for the stability of the currency project.
The latest opinion polls show that the radical left coalition SYRIZA, which came second in Sunday's vote, could do even better in a new vote, potentially overtaking New Democracy, the conservative pro-bailout group that came first.
Such a result could tip Greece closer to leaving the currency zone, even though polls show 75-80 percent of Greeks want to keep the euro but not the harsh EU/IMF bailout terms.
Banks in Europe and beyond have already begun quietly preparing for the possibility that Greece will have to reintroduce the drachma, the currency it gave up a decade ago when it joined the euro.
"The future of Greece in the euro zone lies in the hands of Greece," German Foreign Minister Guido Westerwelle told parliament in Berlin.
"We want to help and we will help Greece, but Greece has to be ready to accept help. If Greece strays from the agreed reform path, then the payment of further aid tranches won't be possible. Solidarity is not a one way street."
FRANCE DEFICIT CONCERNS
While European policymakers remain deeply concerned about the potential for Greece to cause problems, Austria's finance minister said the region was now more insulated from the threat.
"Now the contagion risk is not there to the same extent, so I assume the banking landscape in Europe would be prepared for this," Maria Fekter told Austria radio.
Contagion risks may have diminished, but the forecasts from the Commission suggest there are a host of deficit, growth and unemployment problems riddling economies beyond Greece, including Spain, Italy, Portugal and potentially France.
In rare bright spots, Rehn said Italy and Portugal were on track to meet their targets and did not need to take additional savings measures.
The Commission said it expected Spain's economy to contract 1.8 percent this year and a further 0.3 percent in 2013, leaving the country climbing a mountain if it is to reduce its budget deficit by a large margin and tackle 24 percent unemployment.
What's more, the country's major banks are in the midst of a capital restructuring that will see more than 180 billion euros of toxic assets moved into a 'bad bank' and potentially several dozen billion euros more.
"Spain stands out like a sore thumb," Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, said of the economic forecasts.
"Not only does the Commission expect the recession to be more severe and protracted, the anticipated fiscal slippages are increasing, with no progress expected next year. This is the strongest indication yet that austerity if failing in Spain."
Spain had promised the Commission it would cut its deficit to 5.3 percent this year and to 3.0 percent in 2013, and has already announced a series of measures to hit that goal, including raising valued added tax and cutting health spending.
But it is the powerful Spanish regions that most need to be reined in, Rehn said, and those steps are still to be outlined. The Commission's forecasts don't take into account upcoming adjustments, but even when those are added it remains unlikely that Spain will meet its targets.
That has led some EU officials to suggest that Spain could be offered leeway, perhaps with its 2013 target of a 3.0 percent deficit being delayed by a year.
However, Madrid itself has said it does not want any wiggle room or concessions and Rehn gave no hint of such an easing, saying the Commission would determine by May 30 "whether and how much more fiscal measures" Spain might need to take.
Another area of concern is France. While the country is forecast to grow 0.5 percent this year and 1.3 percent next, its budget deficit is expected to be 4.5 percent in 2012 and be only marginally lower in 2013 at 4.2 percent.
Incoming President Hollande has promised to create 150,000 new jobs and raise spending by 20 billion euros. He has also pledged new taxes to raise revenue by 29 billion euros, bringing the budget into balance by the end of 2017.
But that may not be sufficient for the Commission. Any failure to deliver on the 3.0 percent 2013 target could lead to France being placed under the excessive deficit procedure, which can lead to fines.
The last thing EU policymakers want is another euro zone country following the path of Greece, Ireland, Portugal and Spain, and especially not the region's second largest economy.
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