Spain says deficit target must wait 2 more years amid slump

Amid 27% unemployment environment, Spain "throws in towel" on austerity

Spanish Prime Minister Mariano Rajoy sought a two-year extension to meet European Union deficit rules, as he lowered his growth forecast and predicted little relief from a record 27% unemployment rate.

Testing EU leaders’ promise of greater policy flexibility, Rajoy’s Cabinet today approved a plan to cut the shortfall of 10.6% of gross domestic product back within the EU limit of 3% by 2016 instead of 2014 as demanded by euro-area governments. The economy will shrink by 1.3% this year, compared with a September forecast of 0.5%.

“Spain has, to all intents and purposes, thrown in the towel on fiscal austerity,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “This is a belated acknowledgment on the part of the Rajoy government that its macroeconomic policies have failed.”

Officials in Brussels and Berlin have indicated they’re ready to ease deficit-reduction deadlines, with the euro area in its second year of recession. Spanish output has contracted for seven straight quarters. In mid-2012, Rajoy had already won a one-year extension until 2014 to meet the 3% target.

Deepening Slump

The government will take measures to enable the economy to grow 0.5% next year, Deputy Prime Minister Soraya Saenz de Santamaria told reporters in Madrid. That compares with a July forecast for a 1.2% expansion in 2014.

“2014 is the year of recovery,” Economy Minister Luis de Guindos said, sitting alongside Saenz at a press conference. “We’ll collect the fruit of the economic reforms we’ve done.”

The yield on Spain’s 10-year bonds rose 1 basis point to 4.30% as of 2:36 p.m. Madrid time after trading as low as 4.25% before the announcement. That compares with a euro- era high of 7.75% in July, before the European Central Bank pledged to support the euro.

Spain’s budget deficit will be 6.3% of GDP this year and will fall to 2.7% by 2016. Excluding loans from its banking bailout, Spain’s deficit was 7.1% of GDP last year, compared with 9.1% a year earlier, Eurostat data show.

“Spain is turning the corner,” Budget Minister Cristobal Montoro said. “This is what is opening up the doors to finance the country and this finance will create growth and jobs.”

The total stock of government debt will reach 96.2% of GDP next year and 99.8% in 2016.

Rajoy’s new economic plans include measures to boost the supply of credit for smaller companies. The government says its labor rules-overhaul implemented last year contributed to higher exports as it enabled companies to cut costs.

Jobless Rate

Still, it increased its jobless rate prediction to 27.1% for 2013 from 24.3% and estimated it at 26.7% next year. In the first quarter, the rate was 27.2%.

“Spain faces big risks,” said Robert Wood, an economist at Berenberg Bank in London. “The capacity to react to further economic deterioration is much more limited now than it was a couple of years ago so it’s pretty important growth returns sooner rather than later.”

The European Commission, which will assess Spain’s fiscal performance and policies next month, yesterday signaled “excessive macroeconomic imbalances” remain. “Very high unemployment and excessively tight financing conditions have exposed the vulnerabilities represented by those imbalances,” Economic and Monetary Affairs Commissioner Olli Rehn said.

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