The measures announced yesterday include big spending cuts and tax increases on large companies, but there was no increase in the sales tax, as had been widely-predicted in the run-up to the administration's first fully-fledged budget.
Finance Minister Cristobal Montoro said it was the biggest deficit cut since Spain regained democracy in 1977 after the death of Gen. Francisco Franco. Spain is having to take drastic measures to get a handle on its debts, even at a time of recession which has seen unemployment balloon to nearly one in four, as investors remain skeptical that it can avoid the same bailout fate that befell Greece, Ireland and Portugal. We are taking extraordinary measures because the situation is extraordinary, Montoro told a news conference after a Cabinet meeting at which the budget plan was passed.
The blueprint will go to Parliament on Tuesday and is expected to be formally passed in June.
The plan is that Spain will reduce its budget deficit to 5.3 percent of its gross domestic product from 8.5 percent last year. The challenge is doing so as the economy is in recession and unemployment stands at nearly 23 percent. Spain's economic output last year was worth a little over a trillion euros, or double the size of the three bailed out economies combined. Many in the markets think the euro's long-term viability rests on whether the country can avoid a bailout that would stretch the resources of its partners in the 17-country eurozone.
Deputy Prime Minister Soraya Saenz de Santamaria said the 2012 draft budget calls for cutting central government ministry spending by an average of nearly 17 percent and freezing civil servant wages. Overall government spending will be cut by 17 billion euros ($22.6 billion). Saenz de Santamaria said retirement pensions will remain indexed to inflation, and VAT taxes a levee on sales and services will not be raised, contrary to what some had believed. Civil servant wages, already cut in 2010 will remain frozen but not be further reduced.
The austerity plan from the government, elected last December, came a day after a general strike over labor reforms that make it easier and cheaper for companies to lay people off.
Separately, Montoro announced plans for a tax amnesty: undeclared assets or those hidden in tax havens can be repatriated by paying a 10 percent tax, with no criminal penalty.
On the corporate taxes, he said that rather than actually raise rates, what the government will do is eliminate deductions that companies have been entitled until now and which lowered their effective tax liability.
The country's benchmark Ibex 35 stock index rose after the announcement, posting a 0.92 percent increase in the day.
The budget has been long awaited. Until now the government has been operating on an extension of the 2011 budget.
The government has come under criticism in Brussels for delaying the new budget until after a regional election last weekend.
Although Spain's borrowing rates have fallen in recent months, they have edged back up recently. That was partly due to the government decision to put off presenting the 2012 budget until after the regional election Sunday in Andalusia, in which the ruling Popular Party had hoped to extend its control to a Socialist stronghold and thus to a historic level. But it failed to win an absolute majority and thus will remain in the opposition.
Bond investors also worried that the general strike and protests might push the government to water down its reforms.
But Saenz de Santamaria said one way or another the government will achieve the 5.2 percent deficit target.
The yield on Spanish benchmark 10-year bonds was at 5.41 percent on Friday, up from 4.96 percent a month ago. By contrast, the interest rate on the equivalent German bonds considered the safest in Europe was only 1.82 percent.
The austerity package will draw money out of the Spanish economy at a time when it is entering recession for the second time in three years.
Many economists in Madrid say that, for the time being, Prime Minister Mariano Rajoy is clearly governing more with an eye to satisfying investors and officials in Brussels than avoiding criticism at home.