Spain's new government has announced spending cuts and tax increases worth an estimated EUR 27bn in an endeavour to reduce the gaping fiscal shortfall from 8.5% of GDP at the end of last year to 5.3% by December 31st. Most of the pain is being absorbed by departmental spending – all ministries are to reduce spending by 17%. In addition, power prices are to rise by 7% and the tariffs that electricity companies pay is to rise by 5%. Also, larger companies are to be taxed more heavily, the system for corporate tax payments is to be reformed, corporate tax deductions are to be reduced and there will be a crackdown on tax fraud. These tax modifications are expected to generate EUR 12.3bn in additional revenues in the current year. Budget Minister Montoro claims that central government will reduce the size of its budget by 2.5% of GDP. Recall that Spain has vowed to reduce the size of the fiscal deficit this year by 3.2 percentage points of GDP, so the balance of the fiscal adjustment will come from the regional governments. This is a tough package. Politically, it should help to placate growing civil unease as pensions, VAT and social security have all been left untouched, although Rajoy will inevitably be forced to return to them. Income taxes were raised back in December. Rajoy's ministers will discover that chopping spending by 17% across the board in such a short time is an immensely difficult task. At the very least it will result in significant extra unemployment amongst public sector workers, at a time when the unemployment rate is already above 23%. With the economy already in recession, it would be extremely surprising if this package is sufficient to lower the deficit to the 5.3% target. Neither investors nor traders will respect the failure to tackle benefits, implement a VAT hike or rein in pensions
Also in today's Daily Forex Brief:
- Is Europe doing enough?
- Chinese confusion
- Yen may struggle to hold recent gains