VAT increase causes inflation to jump to 3.5 percent in September

The hike in the valued added tax rate at the start of this month pushed inflation to 3.5 percent raising the question of whether retirees will be compensated for the loss of purchasing power in their state pensions and the impact of this on the government’s deficit-reduction plans.

According to a flash estimate released Friday by the National Statistics Institute (INE), the consumer price index jumped from 2.7 percent in August to 3.5 percent in September, the highest level since May of last year. “This was mainly the result of an increase in prices in most of the sectors,” the INE said. The institute is due to publish a breakdown of the figures on October 11.

The government raised the standard VAT rate from 18 percent to 21 percent and the reduced rate to 10 percent from eight percent. It also moved items that carried the reduced rate to the standard rate.

The government is obliged to compensate pensioners for any increase in inflation above the official target level, which was one percent for this year. The government normally analyzes the situation based on the level of inflation in November. Analysts expect the impact of the VAT hike to continue to filter through in the next few months. A number of companies have said they will not pass the hike on to their customers.

At the current level of inflation, the Social Security system would have to fork out 2.5 billion euros to boost pensions this year, with another payment of the same amount at the start of next year.

In the 2013 draft state budget, the government said it would raise state pensions by one percent and also compensate them for any rise in inflation above that amount. In order to do so, it will withdraw over three billion euros from the Social Security’s pension reserve fund, which currently has assets of 67 billion euros.

At a presentation of the budget yesterday, Finance Minister Cristóbal Montoro sidestepped questions on whether the government plans to abolish the law that guarantees compensation for pensioners if inflation comes in above target.

Montoro said it was important for the economy to maintain pensioners’ spending power. “We are guaranteeing the incomes of almost 10 million people who receive those pensions,” he said.

The finance minister on Thursday underscored the government’s commitment to meeting its deficit reduction targets, which include trimming the shortfall in its finances from 8.9 percent last year to 6.3 percent and 4.5 percent in 2013.

A payment of five billion euros to pensioners to compensate for inflation this year would leave the government needing to finding savings equivalent to around 0.5 percent of GDP to meet its deficit target for the year or to further draw on the pension reserve fund. “The reserve fund is there to be used,” Montoro said on Thursday.

Economy Minister Luis de Guindos said Thursday the government intends to introduce changes to the pension system to bring the effective retirement age in line with the statutory figure, and to ensure its sustainability by revising the parameters on which benefits are calculated.