Spain's new PM set to launch austerity drive

Prime Minister Mariano Rajoy has pledged to turn Spain's battered economy around by meeting tough budget deficit reduction targets while reforming a disastrous labour market and pulling the country out of a prolonged slump.

But since he has had only a week to view the books left by the Socialists and the 2012 budget has still to be decided, the measures to be announced after the weekly cabinet meeting will be just the start with lots of pain further down the road.

The Economy and Treasury Ministries denied reports earlier in the week they would announce €4 billion of cuts today.

Spain has been under intense market scrutiny about its ability to control public finances and Madrid has seen risk premiums soar to record highs linked to contagion fears after Greece had to apply for an international bailout in May 2010.

The Socialists - led by former Prime Minister Jose-Luis Rodriquez Zapatero - reduced the budget shortfall from 11.2 percent of gross domestic product in 2009 to an expected 6.5 percent this year and Rajoy must take up the baton and bring the deficit down to 4.4 percent of GDP in 2012.

To do so, the government needs to find savings of around €20 billion, but with the exact state of public accounts unknown until the country's 17 autonomous regions report their own balances, figures will not be finalised until late March.

Rajoy told parliament last week that he would decree an extension of the 2011 budget until March 31 and pass emergency spending cuts for the first quarter. He also said the 2012 spending ceiling would be set later in January.

A hiring freeze in most of the public sector and a freeze in the minimum wage, the first since it was introduced 30 years ago, are the only details of the cuts known so far. And Rajoy said the only spending increase would be an inflation-linked state pension hike.

The government may also reveal some details of a law, that will not be passed until January, to implement an earlier constitutional amendment on fiscal discipline.

Rajoy is faced with a difficult balancing act, but has a strong mandate with a parliamentary majority.

On the one hand he needs to reduce the deficit through dramatic spending cuts, but on the other he must increase competitiveness and restart a stalled economy. He has already proposed some tax breaks for companies.

Spanish wages have risen sharply in the last few years - by 20.8 percent in 2003-2008 compared to just 9.7 percent in Germany according to data from the IESE business school - stripping the workforce of its competitive edge.

The collapse of the property market after the 2007 global credit crunch and shrinking consumer confidence have hit the economic cornerstones of construction and services, leaving Spain struggling to grow since emerging from recession in 2010.

Economy Minister Luis de Guindos said this week he expected a weak start to 2012 and many economists believe Spain has already entered a recession which could drag on for several quarters.

Meanwhile, a perceived failure by European leaders to create a credible backstop against the euro zone debt crisis has put peripheral economies like Spain in the limelight and means Rajoy will need to show he has a tight hold on the economy's reins.