Spain unveils $36 billion austerity package

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By DANIEL WOOLLS, Associated Press

MADRID (AP) — Spain's new conservative government has unveiled a €27 billion ($36 billion) deficit-reduction package that it hopes will convince its partners in Europe and wary international investors that it won't need a bailout.

The measures announced Friday 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 full 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 taking drastic action to lower its debts, even at a time of recession which has seen unemployment balloon to nearly one in four, as investors remain skeptical it can avoid needing a bailout like 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 for Spain to reduce its budget deficit to 5.3 percent of its gross domestic product from 8.5 percent last year.

Spain's fate is crucial to the future of the euro, since bailing it out would severely test the resources of its partners in the 17-nation currency bloc. Spain's economic output last year was worth a little over a trillion euros, or double the size of Greece, Ireland and Portugal combined.

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 ministry spending will be cut by €14 billion ($18.7 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 a tax evasion 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, the government will eliminate deductions that companies have been entitled to until now and which lowered their effective tax liability.

In a previous austerity package unveiled in December, the government raised income and property taxes. But it left them alone this time and focused on the corporate world, although the vast majority of Spain's companies are small- to medium-sized, with fewer than 50 employees.

"The aim is very clear — it's just to present the budget in a way that people think the effort is being shared in an equal way," said Antonio Barroso, a London-based analyst with the Eurasia Group consulting firm.

He called the budget cuts tough and said the deficit goal will be challenging to reach. Spain's exporters are very resilient but domestic demand is depressed and small- and medium-sized companies are highly dependent on credit that "is not flowing," Barroso said.

Antonio Moreno Ibanez, an economics lecturer at the University of Navarra in northern Spain, said Spain needs economic growth and the key will be getting credit flowing again. "That is what is going to create jobs and create a virtuous cycle," he said.

He noted that while the tax amnesty will help bank liquidity, the fight to cut the deficit will have a recessionary impact.

Market reaction to the budget was mostly positive, with the benchmark Ibex 35 stock index up 0.8 percent shortly before the closing bell.

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 5.35 late 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.

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Barry Hatton contributed from Lisbon.

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