Madrid Austerity Plan Boosted to $80 Billion

The Wall Street Journal

MADRID—Spanish Prime Minister Mariano Rajoy announced new austerity measures Wednesday that should help Madrid cut its budget deficit by €65 billion ($80 billion) through to 2015, and warned the euro-zone's fourth-largest economy may not grow at all next year.

In an impassioned address to parliament, Mr. Rajoy called on all Spaniards to back the measures, which include a value-added tax increase to 21% from 18% and cuts to jobless benefits and public-sector wages, saying Spain's economic situation is "extraordinarily serious."

The government had previously said it would need to make no additional cuts this year to meets its budgetary targets, and had rejected the VAT hike. Previously announced measures account for most of the €65 billion target, according to a spokeswoman for Mr. Rajoy, but the precise size of the new cuts wasn't clear as the government's spending and revenue projections have fluctuated since it released its annual budget in March.

The additional measures were swiftly welcomed by the European Commission, the executive branch of the European Union.

But analysts said the moves would hurt Spain's recovery from recession and might not save the country from needing a full-fledged financial bailout on top of a plan to support its struggling banks with up to €100 billion in EU loans.

As Mr. Rajoy spoke during a six-hour parliament debate on austerity, hundreds of coal miners and their supporters rallied in Spain's capital against government plans to end subsidies for their sector. Some protesters threw rocks and firecrackers at police, the latest sign of growing social unrest in a country mired in an unprecedented, five-year-long crisis.

Previous cuts included in the €65 billion total have already led to an income-tax increase as well as steep budget reductions for all ministries. They also come as Spanish officials are separately negotiating detailed conditions for the EU's bank bailout that may force Madrid to give up most of the control over its banks to European institutions, and impose losses on holders of banks' subordinated debt.

"We are trying to stick to a path that is not easy, short or comfortable, but we can't avoid it—this is the only one that leads to recovery," Mr. Rajoy told lawmakers.

The new measures also include a cut in jobless benefits for new claimants, a significant step in a country where unemployment represents almost 25% of the workforce, and a salary cut of around 7% for central government employees. The measures also seek €3.5 billion in savings linked to public services provided by local governments.

With Madrid anticipating a 1.7% economic contraction this year, euro-zone finance ministers agreed Monday to relax Spain's budget-deficit targets to 6.3% of gross domestic product in 2012, from a previous target of 5.3%. Still, tax revenue has dropped due to what Mr. Rajoy on Wednesday called "the second-deepest recession in Spain's history." Many observers say that even the less-stringent targets would be hard to meet.

Spain reported a budget deficit of 8.9% of GDP last year.

"Raising indirect taxes in Spain now is tantamount to economic destruction," said Ioan Smith, a director in London-based Knight Capital brokerage.

The latest austerity cuts were roundly criticized by trade unions, which threatened strikes in response. The VAT increase was badly received by much of corporate Spain.

However, clothing retailer Inditex SA—Spain's largest company by market value and owner of the popular Zara store chain—said it would absorb the tax increase and keep its prices stable.

Spain's borrowing costs eased Wednesday. The 10-year bond yield was 0.16 percentage point lower at 6.62%, after rising close to 7% earlier in the week, a level economists deem unsustainable.

"The Spanish government is trying to convince financial markets that its policies are credible in order to generate some appetite to buy its sovereign debt, and that's quite a tough job now," said Ken Wattret, chief euro-zone market economist at BNP Paribas. Mr. Wattret expects the Spanish economy to contract 1.6% this year and 1.4% in 2013, as the austerity drive combines with severe problems in the country's banking and housing sectors following the implosion of the once-mighty real estate market.

Since Mr. Rajoy's conservative Popular Party has a strong majority in parliament, he isn't expected to find significant challenges in getting the measures approved. But he still acknowledged repeatedly that the austerity drive would hurt Spaniards and called for solidarity. Recent polls have shown that austerity is having only a moderate negative effect on Mr. Rajoy and his conservative party.

"Spain is in a very bad situation, and we have to cut," said Mila García, a 38-year-old waitress at a cafe in downtown Madrid. "I don't like it, but it's necessary."

—Ilan Brat and Dan Strumpf contributed to this article.

Write to Nicholas Winning at nick.winning@dowjones.com and Davíd Roman at david.roman@dowjones.com