IMF calls on Spain to raise VAT and cut public-sector wage bill

The International Monetary Fund on Friday advised Spain to raise the value-added tax rates “now” and introduce a further cut in public-sector wages in order to avoid a large overrun in its deficit-reduction targets.

In its Article IV report on the Spanish economy released Friday, the IMFsaid the outlook for Spain is “very difficult.” “The economy is in the midst of an unprecedented double-dip recession with unemployment already unacceptably high, public debt increasing rapidly, and segments of the financial sector needing recapitalization,” the report said.

The IMF acknowledged the number of major policy actions taken by the government of Prime Minister Mariano Rajoy, but noted that “market confidence remains weak.” It said the country needs to come up with an “ambitious policy response” that should focus on fiscal consolidation and a restructuring of the banking sector, without forgetting the need for structural reforms to boost growth.

The multilateral agency described as “very ambitious” the Rajoy administration’s commitment to reduce the public deficit from 8.9 percent of GDP in 2011 to 5.3 percent this year and predicted it was “likely” to be missed, with revenues expected to come in below budget, while spending cuts are likely to take time to have an impact.

The IMF’s experts, therefore, believe more measures should be taken on the revenue side, advising that no options in this area should be ruled out. It reiterated the need for increasing indirect taxes, including VAT, with the difference that this time around they called for such action to be “taken now.”

The report said a reduction in social security contributions would be “desirable” but should take second place to controlling the deficit. It also called for the across-the-board tax rebate on mortgage payments reintroduced by the Rajoy government in December to be eliminated. It also warned against a repetition of the tax amnesty on undeclared cash introduced by the government, and called for a more “aggressive” privatization drive.

The IMF report comes a week after it estimated the Spanish banking sector needs an additional 37 billion euros in funding to cover potential future losses under an adverse economic scenario. That figure could double if the restructuring needs of distressed banks form part of the picture.

The agency stated the obvious in saying that despite Europe’s backing for a bailout for Spain’s banks, market conditions remain weak. Spain’s risk premium was steady at 543 basis points on Friday, but not far off a euro-era high of 552 basis points.

The IMF said Spain needed to enhance productivity and cut costs to provide a structural stimulus to the economy. “These are inherently complex and difficult reforms but critical if growth is to be inclusive and job-rich,” the report said.