Brussels says Spain has room to raise VAT further

The European Commission on Tuesday gave Spain a pass mark for its compliance with the terms of the bailout it received to clean up its banking sector, but Brussels insisted more had to be done on the reform front.

“In general, the mission found that the policy conditionality of the program has so far been met and the program, and more widely the recapitalization and reform of the financial sector, is on track,” the Commission said in a report on the joint EC/European Central Bank mission to Madrid in the period January 28 - February 1.

Brussels noted that the financial markets have stabilized and that the liquidity problems of the Spanish banks have eased. However, it added the following rider. “In order to build on this momentum, it will be important to maintain the pace of reforms in order to overcome the still significant challenges and conclude successfully the program.”

The report concluded that there is no apparent need to disburse further funds to Spain other than the 41.4 billion euros it has already received to recapitalize the banks that have been nationalized and to inject capital into the asset management fund Sareb, the so-called bad bank that is absorbing the toxic property assets of the sector.

While the government has pledged to reverse tax hikes introduced as part of its fiscal consolidation plan in order not to strangle a long-awaited economic recovery, Brussels suggested raising the reduced value-added tax further, as well as levies on the energy sector.

“The tax-to-GDP ratio as well as VAT revenue and revenue from environmental taxes in Spain are among the lowest in the EU,” the report pointed out.

The EU executive also wants Madrid to keep closer tabs on the regions by implementing the Budget Stability Law to reinforce early warning mechanisms for deviations from public spending plans.

Despite the improvements, Brussels noted the ongoing credit crunch, pointing to an annual decline in credit of eight percent last year, which encompasses a fall of 15.8 percent in loans to companies and four percent for households. This in turn is holding back the economic recovery.

 Brussels also lamented slow progress in reforms of key service and product sectors, particularly highlighting professional services. It also sees “considerable risks” to the budget from the so-called tariff deficit, the difference between the regulated rates charged to consumers for electricity and the cost of energy production.

It noted a certain moderation in wage demands, possibly as a result of the labor reform introduced in February of last year, which makes it cheaper and easier to sack workers. However, given the disturbing high jobless rate of 26 percent, it recommended that the impact of the reform be closely monitored.

But despite the ongoing recession and high unemployment, Brussels insisted on its austerity recipe for the Spanish economy. “Notwithstanding the significant policy progress already made, further determined advances remain necessary in the consolidation of public finances, including reinforcing the institutional framework,” the report said.