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March 30 (Bloomberg) Prime Minister Mariano Rajoy will unveil the most austere budget since before Spain's return to democracy in 1978, risking a deeper recession in a bid to avoid succumbing to Europe's debt crisis.
"There's interest in seeing how they are going to manage this particular trick of cutting the budget so aggressively," said Harvinder Sian, an interest-rate strategist at Royal Bank of Scotland Group Plc in London, during a telephone interview. "The recession will be dramatic."
The yield on Spain's 10-year bond has risen 55 basis points since March 2 when Rajoy unilaterally raised his deficit goal for 2012, as a deepening economic slump compounded a bigger- than-forecast shortfall last year. The yield was at 5.43 percent at 11:05 a.m. in Madrid, leaving the difference with comparable German debt at 362 basis points, down from yesterday's close of 365, the highest in almost four months.
Budget details will be released around 2 p.m. in Madrid after the weekly Cabinet meeting. Rajoy, in power since December, has pledged to trim the deficit to 5.3 percent of gross domestic product even with the economy mired in the second recession since 2009 and unemployment topping 23 percent.
Socialists' Efforts
The promised deficit reduction of 3.2 percentage points of GDP, the equivalent of 34 billion euros ($45 billion), would be the biggest by that measure since at least 1980. That's more than the cuts of 2.7 percentage points achieved by his Socialist predecessor, Jose Luis Rodriguez Zapatero, in the previous two years.
Zapatero managed that reduction by raising value-added tax and cutting civil servants' pay by 5 percent, options that Rajoy has ruled out. Rajoy will also operate in an economy forecast to shrink 1.7 percent this year, while Zapatero enjoyed an expansion of 0.7 percent growth last year and a contraction of just 0.1 percent in 2010.
"What I expect is some tweaking of loopholes of tax exemptions for corporations and households as well as probably quite a crackdown on ordinary spending by the central government," said Gilles Moec, co-chief European economist at Deutsche Bank AG in London, during an interview on Bloomberg TV. "I would expect roughly a quarter of cuts to come from the central government this time and the rest to come from the regions."
Riling Allies
Rajoy riled European Union partners with his March 2 announcement at a summit in Brussels that he had raised Spain's deficit target to 5.8 percent of GDP from the 4.4 percent initially pledged. Earlier he had attended a ceremony to sign a treaty aimed at ending the debt crisis by enforcing fiscal discipline. EU allies pushed back and got Spain to agree on March 12 to a 5.3 percent goal.
Rajoy tried to raise the target after his predecessors left him with a deficit of 8.5 percent of GDP, dwarfing the 6 percent the Socialists had pledged to the EU.
"The significance of the budget is to demonstrate commitment," said Marc Chandler, the head of global currency strategy at Brown Brothers Harriman in New York. "Budget shortfalls last year and then this year and the way this was handled did not build confidence."
Tax Increases
Spaniards have already had a taste of Rajoy's budget- cutting. The premier raised income tax and slashed spending by 9 billion euros in December in a 15-billion euro package designed to carry public finances through until the 2012 budget is approved.
Fitch Ratings said on March 27 that a deficit of 6 percent was likely this year and that Rajoy's goal to get Spain back within the euro-region's 3 percent deficit-ceiling in 2013 was "unrealistic."
Additional austerity will likely be met with more popular unrest. Unions held a general strike yesterday, hobbling transportation and manufacturing across the country. Less than a week earlier, the People's Party failed in a bid to unseat the Socialists in a regional poll in Andalusia, the third biggest regional economy. The PP also failed to make advances in voting in Asturias region.
Polls had indicated that the PP would win in Andalusia and the result suggests that Rajoy's austerity drive may be eroding the support that led to his landslide victory in December, Ricardo Santos, a European economist at BNP Paribas in London said in a March 26 report.
Editors: Andrew Davis, James Hertling