Spain's government is putting finishing touches to an up to 30 billion euro package of spending cuts and tax hikes to help it meet this year's deficit targets, sources with knowledge of the matter said.
Running over several years, the programme could involve raising Spain's main consumer tax, a new energy levy, reforms to the pension system, pay cuts for civil servants, new motorway tolls and another drastic reduction in ministry and regional spending, the sources said.
Some measures may be announced next week, when the EU is likely to grant the government an extra year to cut its deficit below 3% of output, and others could be presented over the summer and included in a multi-year budget plan due to be prepared in August.
Spain's highly-indebted regions and banks badly hit by a property crash four years ago have put the country firmly in the sights of investors who fear that, given its size, it could derail the entire single currency project if its economy collapses.
The new austerity drive aims to put Spain back on track to meet its deficit goals for 2012, though some questioned whether it would simply add to the country's problems by entrenching its recession even more deeply.
Data for the first five months of the year revealed spending and revenue slippage that makes the current objective unattainable without new cuts.
"The idea is to implement cuts worth 3% of gross domestic product. Everything is under review," said one of the sources with knowledge of the government's thinking.
With Spain's nominal GDP totalling about 1 trillion euros a year, the cuts would be worth up to 30 billion euros over several years and would come on top of savings plans of about 48 billion euros already passed.
"The idea is to cut the cost of the public service, freeze pensions, cut unemployment benefits," the source said, adding that an increase in sales tax was a matter of intense debate with the government.
Three other sources confirmed the measures were being looked at but said no decision had been yet taken on specific reforms or cuts, and that the package could fall well under 30 billion euros.
The wrong medicine?
Spain is negotiating an up to 100-billion-euro European rescue for its banks and pressing for an EU intervention on its bond market to cut soaring borrowing costs.
But it is unclear if the new austerity plan will be well received by markets wary that too much belt-tightening would choke off any hope of economic recovery.
"More austerity will only make things worse in the short-term," said Nicholas Spiro, from Spiro Sovereign Strategy.
"The market does not need to be convinced that (Prime Minister Mariano) Rajoy's government is serious about fiscal retrenchment. While there are serious doubts about the government's ability to enforce discipline in the regions, the real worry is the lack of growth," he said.
Both the European Commission and the International Monetary Fund have said Spain should not rush to cut its public deficit after the economy fell into its second recession in three years in the first quarter.
The Commission has repeatedly called on Spain to shift the tax burden towards indirect consumer and energy taxes and to better control its devolved regions.
In its latest economic assessment, the IMF also urged Spain to raise its VAT rate - one of the lowest in Europe - and implement pay cuts for civil servants.
Rajoy said on Monday he would speed up his structural reform and spending cuts drive, especially in the regions, while Foreign Minister Jose Manuel Garcia-Margallo said the government would soon implement "severe" budget cuts.
Economy Minister Luis de Guindos, who pledged to take any necessary additional step to meet the deficit targets, said the possibility of relaxing the deficit reduction path would be discussed at the monthly meeting of euro zone finance ministers next Monday in Brussels.
A European source said Spain is set to accept on that occasion the offer of the European Commission to take an extra year, until 2014, to cut its public deficit below the European limit of 3% percent of GDP.
Madrid has so far stuck to a pledge to cit the deficit to 5.3% of GDP in 2012 and 3% in 2013, from 8.9% in 2011.
"A decision will be taken in this direction. There is no other choice," said the European source.
"The idea is to have more realistic objectives and at the same time take steps to show that Spain is really serious about achieving them."
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