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Spain defies Brussels by granting itself the leeway it was denied on the deficit

The target of 5.8 percent is 1.4 percent above that previously agreed with the Commission

Merkel says changed figure makes "no sense" but market reaction muted

Government expects economy to contract 1.7 percent this year

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Spanish Prime Minister Mariano Rajoy at a news conference in Brussels on Friday after an EU summit. EFE

Spain on Friday threw down the gauntlet to the European Commission by announcing a deficit target for this year of 5.8 percent of GDP, 1.4 points above the 4.4 percent goal previously agreed with Brussels.

The figure was announced just a day after Spain at a summit in Brussels failed to get the blessing of its European partners for some leeway in the 4.4-percent target. “The first thing that we do after the new rules [on budget stability] should not be to relax them, “Swedish Prime Minister Frederik Reinfeldt said.

Faced with the prospects of finding budget savings of 44 billion euros to meet the 4.4-percent target at a time when the country is heading for recession and amid growing social unrest about cutbacks and drastic reforms to the labor market that makes it cheaper and easier to sack workers, Prime Minister Mariano Rajoy had pledged a “sensible” budget.

Announcing the figure on Friday in Brussels, Rajoy insisted it fell within the framework of the EU’s Growth and Stability Pact. "If you ask me if it’s in line with the regulations, I say yes, both as recommended by the European Union as well as within the Stability Pact.”

If you ask me if it’s in line with the regulations, I say yes, both as recommended by the European Union as well as within the Stability Pact.”

He said although the headline figure has changed, it remains in line with reducing the so-called structural deficit by 1.5 percentage points a year and insisted it left the government on track to bring the shortfall back within the 3 percent limit dictated by Brussels for next year, as previously agreed.

The Rajoy government has made a firm pledge to uphold fiscal discipline, but in a game of cat and mouse with Brussels over the past few weeks it has insisted the deficit target needs to reflect the reality of a country whose economy is expected to shrink 1.5 percent this year rather than one in which growth was forecast when the 4.4-percent figure was agreed.

Rajoy once again laid the blame on the previous Socialist government for the blowout in latest year’s budget when the deficit came in at 8.5 percent, 2.5 points above target. “This is a sensible and reasonable decision that is the consequence of others not fully their commitments in their day,” he said.

Market reaction muted

The reaction of the financial markets to Rajoy’s act of defiance was muted. The spread between the Spanish benchmark 10-year government bond and the German equivalent was up only 8 basis points at 308 basis points. The blue-chip Ibex 35 index was down slightly.

EU President Herman Van Rompuy said the deficit-reduction targets needed to be maintained because what you gain on the one hand through greater growth you lose on the other in terms of market confidence.

Prior to Rajoy’s announcement, German Chancellor Angela Merkel said it made “no sense” for Spain to change the deficit figure it had agreed with Brussels.

GDP forecast to contract 1.7 percent

The deficit figure was approved by the Cabinet alongside other the other macroeconomic premises that will form the basis for the 2012 budget. These included a forecast contraction in GDP of 1.7 percent, the same figure as the IMF, but greater than the Bank of Spain estimate of 1 percent and the EC’s prediction of a contraction of 1 percent.

The breakdown of the deficit figure calls for a shortfall of 4.0 percent by the central government, 1.5 percent for the regions and 0.3 percent for the country’s municipalities. The Social Security system is expected to be in equilibrium.

The reduction in the shortfall will require the government to find budget savings of 29 billion euros. This includes the 15 billion euros in spending cuts and tax hikes introduced by the administration at the end of last year.

The regions were the main reason for the government overshooting the deficit target for last year. They booked a shortfall of 2.94 percent, more than double the goal set them of 1.3 percent.

At a news conference in Madrid, Deputy Prime Minister Soraya Sáenz de Santamaría the new deficit-reduction target would serve as the basis for an “austere” budget.

The government set a spending ceiling for this year of 118.565 billion euros, which represents a fall of 4.7 percent from last year. Finance Minister Cristóbal Montoro told reporters that the budget for the country’s ministries would be 12.5 percent less than in 2011.

The components of the GDP forecast include a negative contribution from domestic demand of 4.6 percentage points and a contribution from net trade – exports minus imports – of 2.9 points despite what Economy Minister Luis de Guindos described as a slight recession in the euro zone and a slowdown in the global economy.

Growth in exports is expected to slow to 3.8 percent from 9 percent last year, while private consumption will contract 1.4 percent due to higher unemployment. Government spending will fall 11.5 percent due to the austerity drive.

Jobless rate seen climbing to 24.3 percent

The government expects the jobless rate to rise to 24.3 percent this year from 22.85 percent at the end of last year, with the economy shedding a net 630,000 jobs. De Guindos said he “wouldn`t be so bold” as to predict the number of people out of work would hit six million this year after the record 5.3 million at the end of last year.