Spain’s New Austerity Measures Fail to Impress

Spanish Prime Minister Mariano Rajoy is off to a good start! His government is only over 100 days old but he has already implemented a handful of reforms in the labor and finance sectors.

Although his proposals have been met with protests in Spain, he remains committed to slash the budget deficit to 5.3% of GDP in 2012 from 8.5% in 2011. In fact, he introduced another 27 billion EUR worth of austerity measures for 2012 last Friday.

However, despite the conservative government’s efforts, it is still struggling to keep market confidence. Yield on 10-year bonds rose to 5.40% on Friday, up from 4.96% just a month ago.

Spanish Economy Minister Luis De Guindos hasn’t gone into detail on the breakdown of the budget plan yet. But he remarked that the new set of austerity measures will be focused on spending cuts rather than tax hikes.

A lot of market junkies expect to see this when the full breakdown of the budget plan is released tomorrow, Tuesday, April 2, 2012. After all, Prime Minister Rajoy has expressed his opposition to raising taxes before. However, not everyone is convinced that tax hikes would be avoidable.

Economic gurus think that in order to save 27 billion EUR, the government will need to raise income taxes, increase electricity prices, abolish corporate tax breaks, and keep civil servant salaries stagnant for a while.

From the draft of the budget plan, it seems clear that the regional authorities must shoulder the bulk of the burden. They were the ones that deviated from the budget last year, so they must also be the ones to fix the mess. The initial plan dictates that they must cut their deficits by 50% this year.

Because of this, regional authorities are going to face a lot of tough choices ahead. They’ll be forced to make certain budget slashes in both health care and education, which could anger the general public even more. Civil unrest could get more intense, similar to what happened in Greece.

What’s the reaction to the government’s most recent budget plan?

Well, it seems like opinions from financial officials and investors are split.

On the one hand, we’ve got a handful of investors who aren’t happy. The Spanish economy is already expected to shrink by more than 1.7%, and additional austerity measures would probably send the country into a deeper recession.

EU officials, on the other hand, have praised Spain’s efforts highly. For instance, Olli Rehn, EU Commissioner for Economy and Finance, commented that even though Spain is in a difficult situation, the steps it has taken is consistent with its goal to improve the sustainability of its public finances.

We can’t deny that Spain’s newfound commitment to restore investor confidence is commendable. However, it seems as though Prime Minister Rajoy is too focused on impressing EU officials than the domestic economy. Is he concentrating too much on reeling in the budget deficit at the expense of economic growth?