Spain joins euro zone austerity bandwagon

 

Spain became the latest euro zone country to announce sweeping austerity measures on Wednesday as the executive European Commission sought unprecedented power to pre-vet national budgets.

Prime Minister Jose Luis Rodriguez Zapatero said Madrid would slash civil service pay by 5 percent this year, freeze it in 2011 and axe 13,000 public sector jobs this year in a drive to meet European Union deficit targets.

"We have to make an exceptional and extraordinary effort to reduce our public deficit and we have to do it when the economy is starting to recover" he told parliament.

U.S. President Barack Obama, who has become involved in the euro zone crisis because of risks to U.S. banks and economic growth, telephoned Zapatero on Tuesday to press for "resolute action" to strengthen the Spanish economy, the White House said.

Spain enjoyed more than a decade of rapid growth fuelled by EU regional aid and low euro interest rates, and long boasted a healthy budget balance and low debt. But public finances were severely hit by the collapse of a construction bubble in the 2007-8 credit crisis. The economy has lost competitiveness and unemployment stands at 20 percent of the workforce.

After months in denial about the need for tougher measures, Zapatero announced an estimated 6 billion euros in additional savings this year, two days after a global agreement on a $1 trillion rescue package to stabilise the euro.

The euro strengthened and European shares jumped more than 1 percent despite figures showing the euro zone economy got off to a weak start in 2010 that will make deficit cutting harder, with paltry first quarter growth in Germany and France.

"RESOLUTE ACTION"

Spanish and Portuguese borrowing costs soared last week when investors fled peripheral euro zone government bonds as jitters over Greece's acute debt crisis spread to other highly indebted EU countries.

In a drive to tighten fiscal discipline and prevent a re-run of Greece's fraudulent statistics and ballooning deficit, EU Economic and Monetary Affairs Commissioner Olli Rehn was set to unveil proposals for greater budget coordination on Wednesday.

The key plank would be for governments to submit their draft budgets to Brussels for scrutiny and peer review by other member states before they are adopted by national parliament.

Rehn told German daily Die Welt this would enable the Commission and the European Parliament to "identify economic challenges for the EU and the euro zone" at an earlier stage.

But it is a big challenge to national fiscal sovereignty and is likely to face stiff resistance from euro zone heavyweights France and Germany, which want closer supervision of serial budget sinners' finances, but not of their own.

In a pre-emptive response, French Finance Minister Christine Lagarde suggested on Tuesday that each government should put its so-called stability programme - a three-year fiscal plan - to a national parliamentary vote before sending it to Brussels. That could make it harder for EU officials to unpick budget measures.

MARKETS CALMING

Rehn said Greece's crisis had highlighted the weakness of mechanisms which are supposed to show whether European Union governments are sticking to the bloc's budget rules.

The Eurogroup of euro zone finance ministers should also be advised in advance and therefore "play a decisive role in the new system of expanded coordination" he said.

European Central Bank policymakers, meanwhile, said their weekend decision to buy euro zone government bonds on the open market was having the required effect of calming financial markets and halting speculation against sovereign debt.

"Any observer will notice that a number of markets which had been functioning very abnormally are gradually operating more normally" ECB President Jean-Claude Trichet said in an interview on France's Europe 1 radio.

He rejected a warning by ECB governing council member Axel Weber, head of Germany's influential Bundesbank, that the bond purchases could cause inflation.

"All the liquidity that is being injected in through these interventions will be taken back. We are not printing money. Our objective is price stability in the medium and long term" Trichet said.

Trichet also said he agreed with the Commission's proposals for prior surveillance of national budgets.

ECB executive board member Juergen Stark said euro zone central banks would hold the government bonds they bought until maturity, and the ECB would resist any political pressure to allow higher inflation to ease governments' debt problems. But he acknowledged other economies might take the inflation route.

"On the ECB board, we are a very convinced band who will resist political pressure" he told Deutschlandfunk radio. "However, increased political pressure could come from other areas of the world so that globally, central banks could have difficulties.

Economists have said the United States and Britain may accept higher inflation to cope with their debt mountains, leaving the euro zone out of step with a tight monetary policy.