Spain given extra time to cut deficit

 People withdraw money from cash machines adjacent to a boarded up cafeteria on July 3, 2012 in Madrid, Spain.

Story highlights

  • EU to grant Spain more time Tuesday to meet its budget deficit targets
  • In return Spain is expected to commit to more tax increases
  • Comes as Spain's 10-year bond yield rises above 7%
  • EU finance minister are meeting to discuss new measures Tuesday

Spain will be given some relief on Tuesday from its austerity woes when its EU partners grant it extra time to meet its steep budget deficit targets which otherwise risk deepening its recession.

However, in return Mariano Rajoy, prime minister, will commit to a fresh round of tax increases, likely to be announced this week, to shore up revenues and help tackle the country's structural or underlying deficit.

The European Commission will propose at a meeting of EU finance ministers on Tuesday that Spain be allowed to relax its deficit target for this year to 6.3 per cent of gross domestic product, an increase from an earlier figure of 5.3 per cent of economic output, according to a commission official.

Under the revised terms, which ministers are expected to approve, Spain will need to reduce its budget deficit in 2013 to 4.5 per cent of GDP instead of 3 per cent, and to 2.8 per cent by the end of 2014 -- in effect granting the Rajoy government an extra year to meet its targets.

The likely softening of the pace of Spain's austerity measures comes as Madrid's borrowing costs in the bond markets have risen back above 7 per cent for 10 years, once again approaching euro-era highs.

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Spain's challenging fiscal targets have been a source of economic pain and political confusion. In March, Mr Rajoy unsettled markets and angered his EU partners when he unilaterally announced a delay, only to be pulled back into line by Brussels.

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When eurozone authorities came round to the idea of a relaxation of the targets, his government insisted on sticking to the existing deadlines, despite concerns about the vicious cycle of tighter austerity, deepening recession and fragile banks.

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Efforts by EU diplomats to agree the revised Spanish targets earlier on Monday met a hitch when Luxembourg blocked approval, forcing the issue to be debated at Tuesday's finance ministers' meeting.

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Luxembourg and Spain are at loggerheads over an open board seat at the European Central Bank that was originally supposed to go to a Spanish official; most eurozone governments have backed Luxembourg's Yves Mersch for the post, but Spain has blocked his approval until Madrid gets another senior post elsewhere.

Pierre Moscovici, the French finance minister, said he expected the new Spanish targets to be approved. "The proposals on the table seem to me to be able to lead to a consensus," he said.

The relaxation of the deficit targets comes as Spain prepares to finalise the conditions and structure of the up to €100bn in European aid that will be injected into its banking system, and the government readies itself to unveil a fresh round of austerity measures and tax increases.

On Monday, Cristóbal Montoro, Spain's budget minister, said the government was considering increasing the rate of value added tax, while María Dolores de Cospedal, secretary-general of the ruling Popular party, raised the prospect of further reforms to Spain's public administration and the number of public sector workers.

Mr Montoro said his department had calculated that the tax burden for Spanish taxpayers was the lowest in the developed world, with total collection having fallen by 7 percentage points of GDP since 1997.

Mr Montoro said the custom of paying for goods and services without VAT had become a "national sport", and that this was why the government had been forced to focus on tax evasion.

The government is also planning an overhaul of taxation of the electricity sector, where numerous separate taxes overlap at present, and consumers pay both VAT and a special electricity tax.

As part of the negotiations over the structure of the European aid money being used to recapitalise Spanish banks the government has agreed in principle to establish a sector-wide so-called bad bank, which would house assets collected from lenders and manage them jointly.

Such a plan, which would increase the ability of European authorities to oversee the further restructuring of the country's financial sector, has been considered several times by the Spanish government, but dropped due to its cost, and the resistance of larger banks.

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