New Spanish Prime Minister announces major spending cuts

In his first speech to the country's new Parliament, Rajoy said budget stability, a costly fresh round of bank consolidations and reforms to Spain's economy, such as its rigid labour law, would be his central objectives. Rajoy's centre-right People's Party was elected by a landslide in November. It faces a near-impossible task to revive an economy sliding into recession as the euro zone debt crisis widens, while meeting harsh European austerity demands. “We are confronting enormous difficulties and must make very demanding efforts,” Rajoy told Parliament. After a two-day parliamentary debate the self-proclaimed “Mr. Normal” will be sworn in by King Juan Carlos tomorrow and name his cabinet. The euro zone's fourth-largest economy is at the centre of the bloc's debt crisis and investors have driven up Spain's borrowing costs to near-unsustainable levels.

But Rajoy's promises of more austerity has boosted confidence and debt yields have fallen from euro-era highs since the election. The risk premium on Spanish benchmark bonds over German benchmark debt narrowed yesterday by around 4 basis points to 331 basis points. This compares with 491 for Italy. Rajoy began his address with dire warnings for the struggling economy, which is believed to have already fallen into its second recession in three years. Domestic demand is flagging and export growth slowing. Spain's unemployment rate, moreover, is more than double the European Union average at 21.5 percent. Economists said Rajoy may make all the right moves but still fail to save Spain. “The reforms are spot-on, but Spain is facing headwinds that may be beyond Rajoy's measures,” said Silvio Peruzzo, economist at RBS. “The key issue remains that Spain is still extremely vulnerable to any wrong decisions that could be potentially made at a European level, and measures could also be undermined by a deteriorating growth outlook,” Peruzzo said. Efforts by the 17 euro zone members to solve their debt problems comprehensively have been slow coming and relatively unsuccessful to date. Rajoy said if Spain met its public deficit goal of 6 percent of gross domestic product in 2011 - which most economists say is unlikely - the Treasury would need to find 16.5 billion euros ($21.5 billion) in savings next year to meet the next target. He said he would implement a hiring freeze on most of the public sector and announce detailed spending cuts on December 30. But Rajoy outlined some immediate tax benefits for companies in order to boost employment and demand. Small companies and the self-employed will not have to pay taxes before clients have paid them, as they currently do.

Small companies that make their first hire will get a 3'000 euro tax benefit, and corporations with less than 5 million euros in revenue will be put into a more favourable tax bracket. Another business-friendly measure he announced was to move public holidays that fall in the middle of the week to the closest Monday or Friday. This should discourage people from taking more time to stretch the holiday. He also said banks must sell off billions of euros property assets -- the hangover from a building bubble that burst in 2007 -- and then be recapitalized.

But Rajoy did not say whether or not he would form a state-owned bad bank to hold the assets after party sources said he was studying doing so. He said he would raise pensions in real terms -- after the Socialists had frozen them - but pledged that would be his only spending increase. He also hinted at reforms to the country's treasured public health system saying his party will redefine the basic services that the state would guarantee for everyone. Ben May, an economist with Capital Economics, said Rajoy's measures “are a step in the right direction but I am not sure they will do much to end the sovereign's problems with such reluctance to hold the country's debt.”