Spain tests Europe's austerity logic

GABRIELE STEINHAUSER AP Business Writer Published:

BRUSSELS (AP) -- After the 17 euro countries spent much of the past two years tightening their rules against overspending, Spain's high deficit is testing the currency union's dedication to austerity as the way out of the financial crisis.

The eurozone's finance ministers struggled at a meeting in Brussels on Monday over how to deal with a country that, unlike bailed-out Greece or Portugal, vaunted low deficits until the crisis hit.

Economists say budget cuts -- Europe's favored tool to fight the debt crisis -- risk causing more harm than good.

Spain's new Prime Minister Mariano Rajoy earlier this month said his country would run a deficit of 5.8 percent of economic output this year, far above the 4.4 percent it had promised to the rest of the eurozone.

Rajoy insisted that Spain would still manage to bring its deficit down to 3 percent by 2013 -- and thereby back in line with EU rules. But the decision to avoid overly brutal cuts this year threatens to undermine the eurozone's efforts to convince investors that it can prevent countries from running up excessive debts.

While the deep recession in Greece has already raised questions over the benefits of harsh budget cuts, Athens' massive debts left little alternative to slashing spending quickly.

Spain, by contrast, has a debt load that is far below the eurozone average, and economists warn that the biggest danger to the country's economic survival is not its government spending but a steep economic downturn that could further erode an already shaky banking system and real-estate market.

"The Spanish economy is at a fragile point where any excessive cuts to public spending could be self-defeating and trigger a downward spiral of GDP slowdown, rising unemployment, falling tax revenues and collapsing house prices," Sony Kapoor, managing director of economic think tank Re-Define, said in a note last week.

Spain hopes that its promise to stick to the 2013 target will convince the other 16 euro countries to give it some more leeway on this year's budget.

Before the crisis of 2008 rocked Spain's economy and pushed unemployment to record levels, the country was one of only a few euro members that never broke the currency union's debt and deficit limits.

"There is no doubt about the Spanish commitment to fiscal adjustment in this complex environment," Finance Minister Luis De Guindos said Monday. "We are living in a recession, not just in Spain, also in Europe and the main thing is to return to growth and to generate employment."

But while some of his counterparts on Monday seemed to support that logic, they also worried that going soft on Spain may undo close to two years of work on tighter spending rules in the eurozone.

"One will have to create a plan, together with Spain, so that ... the excessive deficit won't exist anymore in 2013, at the very least," Austrian Finance Minister Maria Fekter said as she arrived in Brussels.

However, when asked whether some of Spain's concerns will be accommodated, Fekter quickly pulled back.

"Spain has to make an effort," she said. "One has to be strict, so that everyone knows that we are serious about our paths toward budget consolidation."

Similarly split statements were also made by Eurogroup chief Jean-Claude Juncker, who stressed the 2013 target, and German finance minister Wolfgang Schaeuble, who had a bilateral meeting with his Spanish counterpart ahead of the main get-together.

"The German minister has appreciated the Spanish commitment with the 3 percent for the 2013," De Guindos said after the meeting. "It's a great effort we are committed to in our stability program."

The stricter budget rules are also causing some problems in countries that have always presented themselves as fiscal hard-liners. The Netherlands, which has spent much time lecturing Greece and other struggling states about the importance of cutting the deficit, also risks overrunning its budget targets this year.

Dutch Finance Minister Jan Kees de Jager stressed Monday that while his country would take the "appropriate measures," it was unfair to group it together with some of the other overspenders.

"You cannot of course compare us to other countries, because when you see the confidence on the financial markets, confidence is very high," he told reporters.

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Don Melvin contributed to this story.