Brussels to give Spain two more years on deficit as austerity loses its shine

Amid pressure from the IMF and faced with the fact that output in the euro zone as a whole is shrinking, the European Commission seems to be relaxing its obsession with austerity and is moving increasingly toward the idea that Spain should be given two more years to bring its public deficit back within the European ceiling of three percent of GDP.

Setting the tone for this shift in emphasis, EC President José Manuel Barroso on Monday said: "While I think this [austerity] policy is fundamentally right, I think it has reached its limits."

Barroso was speaking as the EU's statistics office Eurostat unveiled data showing that Spain posted the biggest public deficit last year within the European Union, at 10.6 percent of GDP — a result of the EU bailout to clean up its banks.

The task of taming the shortfall has been exacerbated by the ongoing recession, which the government on Monday acknowledged could be up to three times deeper than it initially forecast.

"Some within the Commission are starting to have serious doubts about the effects of their policies," a high-ranking European source said Monday.

Spain is currently due to bring the deficit back within the EU ceiling by 2014, when the economy is expected to return to modest growth.

Some in the Commission are starting to have serious doubts about the effects of their policies"

The second-biggest public deficit in the EU was posted by Greece at 10 percent, followed by Ireland (7.6 percent) and Portugal (6.4 percent). Germany posted a surplus of 0.2 percent of GDP.

Without counting the bailout the shortfall in Spain's accounts dropped from 9.4 percent in 2011 to 7.0 percent of GDP last year when the government had targeted a figure of 6.3 percent.

The target for the deficit for this year agreed with Brussels is 4.5 percent of GDP, with the government committed to bringing the shortfall back within the EU ceiling of three percent of GDP in 2014. Brussels' final decision on how much slack to give Spain in meeting its deficit targets will depend on its assessment of the government's new macroeconomic scenario for the next three years and the new batch of reforms that are expected to be unveiled this Friday.

In an interview with the Wall Street Journal published Monday, Economy Minister Luis de Guindos said the contraction in the economy for this year is expected to be revised to between 1.0 and 1.5 percent from an initial estimate of 0.5 percent. That would bring the figure closer in line with that of other experts. The IMF last week said it expects Spain's GDP to shrink by 1.6 percent this year before growing 0.7 percent the following year. De Guindos said he expects "slight" growth in 2014.

De Guindos said the new reforms would put more emphasis on economic growth and less on deficit-reduction per se. As such, he ruled out further "significant" austerity measures, predicting that the results of spending caps and the increase in the value-added tax rate would have a stronger impact in coming years.

De Guindos said the government is aiming to achieve a balance between reducing the deficit and growing the economy, noting that one of the main concerns of international investors currently is the lack of economic growth.

The other aspect of investor concern is the rapid build-up in public debt as a result of the deficit. Debt as a ratio of GDP grew from 53.9 percent of GDP in 2009 to 84.2 percent last year, and had already increased further to 87 percent of GDP by the end of February.

However, there are still eight EU countries with bigger ratios, including Italy with 127 percent of GDP, Portugal with 123.6 percent and Ireland with 117.6 percent. The country with the lowest debt ratio was Estonia, at 10.1 percent of GDP. France's debt was 90.2 percent of GDP and Britain's 90 percent.

"Spain doesn't look altogether different from the UK or France," Bloomberg quoted Robert Wood, an economist at Berenberg Bank in London, as saying. "Of course with debt heading up toward 100 percent of GDP, big deficits and the economy contracting, bond yields are bound to be higher than in Germany, but rising up to seven percent wasn't warranted."

Portugal's deficit last year jumped to 6.4 percent of GDP from 4.4 percent in 2011 and 9.8 percent in 2000. The Constitutional Court recently threw out a number of the austerity measures included in the 2013 budget, obliging the center-right government of Pedro Passos Coelho to find savings of 1.3 billion euros elsewhere.

Portugal is also looking for some leeway from Brussels in meeting the EU ceiling of three percent of GDP, with its economy also in recession. The government expects the economy to shrink by around two percent this year after contracting 3.2 percent last year.