With an election due by November 2015, the government is showing wavering resolve to tackle the European Union’s second-highest jobless rate or revamp the tax system after pushing through unpopular measures including a labor-law reform and public sector wage cuts. The government this month rejected tax-change proposals from a task force Budget Minister Cristobal Montoro himself had appointed.
“What threatens Spain is an Italian scenario, where the recovery doesn’t gather enough speed to gain momentum,” said Fernando Fernandez, a professor at IE business school in Madrid and a former International Monetary Fund economist.
As pressure from financial markets and EU peers abates, Spain is paying less to fund itself than Italy, the euro region’s third-largest economy. That has allowed Rajoy to turn his back on measures economists say the Iberian country needs to grow more than 1 percent and dent a 26 percent jobless rate.
Fernandez, a member of Montoro’s tax task-force, said he doesn’t expect the government to follow the group’s advice to boost growth while reining in one of the largest budget deficits in the EU. Spain last year emerged from its second recession since 2008.
“From now on the government wants consensus, it won’t continue using its absolute majority to push aggressive reforms that could achieve growth of 3 percent,” he said in an interview.
Buoyed by a drop in Spain’s borrowing costs to pre-crisis levels, Montoro last week rejected value-added tax increases while maintaining a pledge to cut income tax.
“Leaving Spain’s taxation of consumption unchanged won’t help achieve sustainable growth,” said Victor Echevarria, an economist at BNP Paribas SA in London. “Consumption is currently taxed too lightly while high taxation of labor discourages employment creation and undermines firms’ Competitiveness.”
The popularity of Rajoy’s People’s Party has waned since it won 45 percent of votes in November 2011. Backing for his government, which has raised both income and value-added tax, fell to 30.8 percent in February, according to poll results published by El Pais last month. This week, a poll ahead of the EU elections in May showed it behind Spain’s Socialists with just 25.7 percent of votes, El Pais said.
Rallying political support is coming to the forefront of Rajoy’s agenda as Spain pays the least on record to borrow for three and five years. The Treasury has covered a third of its medium and long-term funding needs for 2014 as the yield on its 10-year benchmark bond has fallen to 3.29 percent from a euro-era high of 7.75 percent in 2012, when the nation sought EU aid.
That’s five basis points less than the amount Italy, which has respected EU deficit limits for the past two years, has to pay for the same period of time. Investors remain wary of the country after a fragmented parliament brought down three governments in the last three years, hobbling efforts to foster growth.
Italy’s economy will expand 0.6 percent this year, half the average of the euro area, according to EU forecasts. Prime Minister Matteo Renzi, who cobbled together a four-party coalition last month, faces the same internal divisions that stymied attempts by ex-Premiers Enrico Letta, Mario Monti and Silvio Berlusconi to revamp the labor market and cut red tape.
By contrast, Rajoy’s government controls parliament after winning the biggest majority in a Spanish election in almost 30 years. Still, it’s dismissing European Commission warnings that it needs to take additional austerity measures to meet next year’s budget deficit goal.
The Bank of Spain today said that the government missed its budget deficit target of 6.5 percent of gross domestic product in 2013. Overspending amounted to 7.1 percent of GDP including aid to the banking sector, it said.
EU and IMF supervision imposed on the country in 2012 in return for aid to bail out a banking sector burdened by bad loans ended this year.
Corrective action taken by the government to finance pensions isn’t enough, central bank Governor Luis Maria Linde said during a news conference today in Madrid. “It is one of the economy’s major financial and social problems and more measures should be taken.”
Spain’s current pensions system “needs to be complemented and that complement can only come from private savings which should be encouraged through the tax system,” Linde said.
Meanwhile, the government has turned down suggestions from the IMF and the Organization for Economic Cooperation and Development to lower unemployment.
Labor Minister Fatima Banez has ruled out a second labor overhaul even as IMF Managing Director Christine Lagarde this month said that Spain needs more changes in labor law to help companies and workers agree on “appropriate” wages. The OECD last month said that the reversal of government aid that encouraged hiring by small companies threatens job creation.
“The government should’ve gone further with the labor reform or pension changes when it was in a position to do so,” said Juan Jose Toribio, a professor at the IESE business school in Madrid and a former head of finance policy at the Economy Ministry. “Now it’ll be very difficult as elections approach and no one expects any party to secure such as strong majority again.”
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