Prime minister Mariano Rajoy's conservative government announces Spain's most austere budget for more than three decades

This article is more than 8 years old

This article is more than 8 years old

Mariano Rajoy's conservative government announced Spain's most austere budget for more than three decades – the day after a million protesters took to Spanish streets.

"We are taking extraordinary measures because the situation is extraordinary," the budget minister, Cristóbal Montoro, said before announcing €27bn (£22.5bn) in spending cuts and tax rises.

Markets and fellow eurozone members increasingly fear that Spain – whose economy is twice the size of that of Greece, Ireland and Portugal put together – could be the biggest threat to their future.

"Spain is going to stop being a problem, especially for the Spanish people, but also for the European Union," finance minister Luis de Guindos said as he prepared to explain the austerity measures to concerned eurozone ministers who were meeting in Copenhagen.

It was unclear whether the complex €27bn adjustment, which included €15bn in tax rises and spending cuts announced in December, would convince the markets.

"This is as austere as it gets. It's a tightening of fiscal policy until the pips squeak," said Nicholas Spiro at Spiro Sovereign Strategy. "There can be no doubting the government's willingness to curb Spain's excessive budget deficits."

Pressure eased slightly on Spain's bond yields on Friday, suggesting the initial reaction was positive, but some analysts said they needed to study the measures more closely.

Montoro avoided raising headline corporate taxes and sales taxes in an attempt to limit damage to consumer spending in a country already tumbling into recession. The government estimates the economy will shrink by 1.7% this year.

He insisted that, with unemployment at 23% and climbing, he had tried to avoid hurting the economy's chances of recovery. But economists have warned the deficit-cutting measures demanded of Spain this year will take two percentage points of GDP off growth, pushing the country into the second part of a double-dip recession.

The adjustment, which amounts to some €570 per Spaniard, mostly came from widely distributed spending cuts, with ministries cutting by an average 17% and a sharp fall in infrastructure investment.

Civil servants, whose salaries were cut by 5% in 2010, were among the biggest losers: their wages were frozen again this year.

Corporate taxes were tightened up, with loopholes disappearing, so that Spain's biggest companies will contribute €5.3bn to the adjustment.

Montoro launched a tax amnesty, appealing to those with money hidden offshore or in the underground economy to take advantage of a one-off, no-questions-asked deal that would allow them to pay between 8% and 10% tax.

Estimated revenue of €2.5bn from that tax indicates that he expects €25bn to appear in a country where up to 20% of the economy is thought to be underground.

Income tax rises announced in December, with top earners hit specially hard, were expected to contribute €4bn.

While Spanish electricity bills will rise by 7% and gas bills by 5%, the government steered clear of measures that would hit Spaniards directly in their pockets.

The measures introduced so far, including reform of labour laws, have already damaged the popularity of Rajoy's People's party just 100 days after it took over the reins of government.

Thursday's general strike came after regional elections in southern Andalucia saw the ruling PP's vote drop to 41% from 46% at the November general election when Rajoy ousted a socialist government.

Rajoy blames the socialists, who had promised to leave the deficit at 6% of GDP last year, for Spain's current plight. Last year's deficit was 8.5 %.

Montoro will take the budget, which does not formally come into effect until May or June, to parliament next week, where it may be altered.

Economists had warned that, in order to meet the €35bn net adjustment demanded by the EU, with falling tax revenues and an economy falling into recession, the real extra adjustment in the last nine months of the year had to reach €40bn.

Spaniards are upset that the EU has demanded such a fierce deficit cut over the next two years – bigger than that asked of the eurozone's bailed-out countries.

While Greece must cut the deficit by 4.7% of its GDP over the next two years, Spain has to find 5.5%. Ireland has been set a 2.6 % adjustment and Portugal 2.9%.