Spain's Prime Minister Mariano Rajoy today announced €65 billion in drastic spending cuts and a VAT tax rise to rein in spiralling sovereign debt.

Rajoy performed a u turn on value added tax after promising he had no plan to boost the levy, and took an axe to state expenditure.

"These are not pleasant measures but they are necessary," Rajoy said.

He said new spending cuts and other measures including a rise in VAT would bring in €65 billion by the end of 2014 to help trim the annual deficit.

The European Union had demanded a VAT rise along with a series of other tough measures even as it gave Spain an extra year to bring its bulging public deficit back to agreed limits.

Among the new measures announced by Rajoy:

- VAT goes up to 21% from 18%, and the reduced rate on some products such as food goes up to 10% from 8%. A special 4% rate on basic needs such as bread is untouched.

- Public administration is reformed to save €3.5 billion, including a drastic cut in the number of publically owned enterprises and a 30% cut in the number of local councillors.

In Brussels, euro zone ministers agreed the previous day to provide a first slice of €30 billion for Spain's banks this month, with €100 billion potentially available in all.

The 17-nation single currency bloc agreed, also, to extend a deadline for Spain to cut its public deficit to the European Union's limit of 3% of gross domestic product by one year to 2014.

As Spain struggles with recession, the bloc agreed to relax the deficit target to 6.3% of GDP from 5.3% in 2012; to 4.5% from 3% in 2013 and then impose a 2.8% goal for 2014. But the euro zone aid comes at a cost. Spain has to present a new austerity plan for 2013 and 2014 by the end of this month.

Euro zone financial chiefs agreed on June 9 on banking aid for Spanish banks, crippled by vast loans made in a property bubble that burst in 2008. And as part of that banking aid, the euro zone insisted that Spain's progress on cutting its deficit and reforming the economy would be "closely and regularly reviewed" in parallel with the banking sector.

Street protests are already mounting over austerity measures in a country with a jobless rate of 24.4%.

Spanish banks face tough conditions for EU bailout

Spain will have to force investors to take losses and allow European Union inspectors to visit bailed out banks in return for a multi-billion-euro rescue, according to a draft deal published today.

The conditions imposed by euro zone partners, widely revealed by Spanish media, will force the government to reform its financial sector in the wake of a banking crisis that is threatening to drag Madrid into a full-blown bailout.

EU finance ministers yesterday offered to provide Spanish banks €30 billion this month, the first batch of a rescue that could reach as much as €100 billion.

With euro zone governments growing tired of tapping taxpayers to help out other nations, the draft deal compels Spain to impose losses on the banks and investors before any aid is disbursed.

"Steps will be taken to minimise the cost to taxpayers of bank restructuring," said the draft memorandum of understanding, which is expected to be finalised at a special meeting of eurozone finance ministers on July 20.

"Banks and their shareholders will take losses before state aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible," the document added.

The draft deal outlines a strict calendar of measures the Spanish government and banks must undertake over the course of an 18-month rescue programme.

The government will have to hire an external consultant to conduct stress tests on 14 banking groups representing 90% of the banking system in order to estimate their capital shortfalls. The exercise must be completed by the second half of September.

Banks receiving euro zone aid will have to open their doors to the European Commission, the European Central Bank and the European Banking Authority. The government will also have to impose caps on executives' bonuses.

"The European Commission in liaison with the ECB and EBA will be granted the right to conduct on-site inspections in any beneficiary financial institutions in order to monitor compliance with the conditions," the document states.

For its part, the Spanish government will have to bolster the independence of the Spanish central bank by transferring by December 31 the sanctioning and licensing powers currently in the hands of the economy ministry.

The government will also have to consult with the European Commission and the ECB before adopting any new laws related to the financial sector, the draft revealed.

The key points; 

  • VAT goes up to 21% from 18%, and the reduced rate on some products such as food goes up to 10% from 8%. A special 4% rate on basic needs such as bread is untouched.
  • Public administration is to be reformed to save €3.5 billion, including a drastic cut in the number of publicly owned enterprises and a 30% cut in the number of local councillors.
  • For the newly unemployed, benefits will be cut after six months from 70% of basic salary to 50%. Previously, the benefit had been reduced after six months to 60% of salary.
  • Certain bonuses paid to top civil servants will be cut, and the Christmas bonuses for top public officials will be eliminated.
  • Environmental taxes will be reformed to comply with the "polluter pays" principle. Tobacco taxes, too, are to be targeted.
  • Deductions for mortgage payments for new buyers will be eliminated as of 2013.
  • Ministerial budgets will be cut by €600m this year.
  • Subsidies for political parties, unions and business organizations will be reduced by 20%.
  • Many allowances to businesses for hiring will be eliminated except those for new hiring by entrepreneurs and hiring of disabled workers.