December 30, 2011 / 4:45 PM / 8 years ago

UPDATE 2-Spain says deficit bigger than expected, hikes taxes

* New govt sees 2011 deficit at 8 pct of GDP vs 6 pct target
    * Announces initial round of 8.9 bln euros of spending cuts
    * Says will hike taxes to raise 6 bln euros
    * Measures seen deepening expected recession

    By Andrés  González and Elisabeth O'Leary	
    MADRID, Dec 30 (Reuters) - Spain's new government said
on Friday that this year's budget deficit would be much larger
than expected and announced a slew of surprise tax hikes and
wage freezes that could drag the country back to the centre of
the euro zone debt crisis.	
    In its first decrees since sweeping to victory in November,
the centre-right government said the public deficit for 2011
would come in at 8 percent of gross domestic product, well above
an official target of 6 percent.	
    It announced initial public spending cuts of 8.9 billion
euros ($11.5 billion) and tax hikes aimed at bringing in an
additional 6 billion euros a year to tackle the shortfall. 	
    "This is just the beginning ... We're facing an
extraordinary and unexpected situation, forcing us to take
extraordinary and unexpected measures," Deputy Prime Minister
Soraya Saenz de Santamaria said.	
    Spain has been under market scrutiny over its ability to
control its public finances, and Madrid has seen risk premiums
soar to record highs on contagion fears as the euro zone debt
crisis spread.	
    Ten days ago the Treasury said the central government budget
deficit was on course to meet a full-year target of 4.8 percent
of GDP, which analysts said would push Spain's overall public
deficit above its 6 percent target for the year.	
    But the scale of the overshoot took some economists by
surprise and led them to forecast a deeper recession, ending the
year on a downbeat note for the euro zone as a whole.	
    "This is a strong shock. I didn't expect this kind of
deficit increase. How can we achieve the objective using
personal income taxes and capital taxes? This means making the
recession much worse," economist at Barcelona ESADE university
Robert Tornabell.	
    While Italy's debt mountain has been the biggest concern in
financial markets in recent months, Spain had been seen as
faring somewhat better. Measures taken by the previous Socialist
government, while costing it the election, have kept the markets
from pushing Spanish yields to unsustainable levels. 	
    But as recession looms across the euro zone, the new
government faces a rocky few years. After Friday's initial round
of tax hikes and spending cuts, it plans to unveil a final 2012
budget by the end of March.	
    The Socialists cut the budget shortfall from 11.2 percent of
gross domestic product in 2009, and the conservatives must take
up the baton and bring the deficit down to 4.4 percent in 2012
and 3 percent in 2013.	
    If the final 2011 deficit hits the 8 percent mark, as the
conservatives say, the government will need to make total
savings worth more than 35 billion euros in 2012 to meet the
official target.
    Spain's economy, the fourth-largest in the euro zone, is
likely to have shrunk as much as 0.3 percent in the fourth
quarter, Economy Minister Luis de Guindos said this week, and
many economists expect output to keep shrinking in early 2012.	
    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.	
    Now, the euro zone debt crisis and fear of economic slump
across the bloc has hit Spanish export growth, the only element
of the economy to promote growth through 2011.	
    The tax hikes announced by the conservatives on Friday,
which they have always said would be counterproductive to a
struggling economy, will be aimed at the country's wealthiest.	
    The government froze civil servants wages, but also pledged
to help the country's poorest by raising pensions and holding
electricity tariffs steady for small consumers.   	
    Beyond deficit reduction, the new government said it would
concentrate its first few measures on the broken labour market,
which has left Spain with an unemployment rate more than double
the European Union average, and the banking system.	
    Spain has rapidly lost competitiveness since the birth of
the single currency bloc as wages have followed a
higher-than-average inflation rate, a situation the
conservatives have pledged to changed through labour reform.	
    Spanish wages have risen by 20.8 percent in 2003-2008
compared to just 9.7 percent in Germany according to data from
the IESE business school.	
    The government is in talks with unions and employers'
representatives to produce a reform plan in the first two weeks
of January.	
    Meanwhile, the banking system has been badly hit by the
burst property bubble and new Prime Minister Mariano Rajoy has
said the banks must be forced to announce losses on the housing
market in a new step in the ongoing restructuring plan.	
    But some economists say that while Spain must reform and cut
costs, its future depends on decisions by euro zone leaders on
creating a viable backstop for troubled regional economies.	
    "There is very little that the Rajoy government can do on
its own to bring down Spain's borrowing costs significantly, not
least as its fiscal policies are going to depress growth
further. The real challenge in Spain is to get the economy
moving," said Spiro Sovereign Strategy's Nicholas Spiro.
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