Spain Set to Breach Deficit Limits for 2012

FT: Spain Defies EU Over Deficit Rules
NYT: Spain
Telegraph: Spain Planning to Breach EU Budget Targets
WSJ: Euro-Zone Ministers Press Spain for a Deal on Deficits

Earlier this month, Spanish Prime Minister Mariano Rajoy announced that the country would not be able to meet its intended budget deficit target for this year. The country had previously set a fiscal deficit target of 4.4% of gross domestic product (GDP) in an effort to reassure Eurozone leaders and investors of Spain’s commitment to tougher fiscal measures. However, due to Spain’s current economic situation, Mr. Rajoy expects this year’s fiscal deficit to surpass the set target and reach 5.8% of GDP.

According to Mr. Rajoy, Spain’s current economic situation makes it difficult for the country to implement further austerity measures (spending cuts and tax increases) needed to meet the 4.4% of GDP deficit target. The Spanish government already passed a €15 billion austerity plan in December 2011 to reduce the deficit. Further tax increases and spending cuts could seriously hurt growth and make it even more difficult for the country to bring its fiscal deficit down. When taxes increase, demand falls as consumers have less income to use to purchase goods. The decrease in consumption causes companies, faced with less revenue, to lay off workers, thus increasing unemployment. Spending cuts such as lowering wages and reducing unemployment benefits can also dampen demand.

It is not feasible for Spain to meet its deficit target since the nation’s 2011 budget deficit was higher than the previous government forecasted. The actual 2011 deficit was 8.5% of GDP compared with a target of 6%. Since the deficit for the previous year was higher than what the government forecasted, the measures taken to bring down the deficit would not be enough to bring down the deficit to the set target. In addition, the current government has predicted that GDP will shrink by 1.7% this year, compared with the growth predicted by the previous government when the original deficit target was agreed. Growth helps to combat deficit as the government will have higher revenues from tax collection. Thus, this slowdown in growth will make it even more difficult for the country to bring the deficit down.

The news of Spain’s higher-than-expected fiscal deficit caused Eurozone leaders to increase pressure on the country to lower its deficit. On March 12, Eurozone finance ministers reached an agreement with Spain for the country to make additional efforts to cut its budget deficit by an additional 0.5% of GDP this year. Mr. Rajoy has stated that despite that higher deficit, Spain will continue to work on achieving the goal of a 3% deficit in 2013, which would bring the country into compliance with European Union law.