Spain's Economy Set to Contract

Spain's central bank said Monday the euro zone's fourth-largest economy will likely contract around 1.5% this year, making it even harder for the country to reach ambitious budget-deficit reduction targets.

In its monthly economic review, the Bank of Spain said the economy will take a hit from a "significant" drop in government and household spending, partially due to strict austerity policies that are only offset to some extent by a positive contribution from foreign demand. The forecast contrasts with a previous central-bank estimate of 1.5% growth in 2012, released in March last year.

The central bank also said Spain's economy likely grew 0.7% last year, following contractions both in 2009 and 2010, but contracted 0.3% in the fourth quarter. It said it is forecasting 0.2% growth for 2013.

The forecast is roughly in line with an International Monetary Fund estimate published last week by Italian news agency ANSA. After it slashed forecasts for euro-zone countries across the board, the IMF is now expecting Spain's gross domestic product to contract 1.7% in 2012 and 0.3% in 2013, compared with a previous estimate of growth for both years, of 1.1% and 1.8% respectively.

These forecasts come at a delicate time for Spain's new government. As it took office last month, Spain's right-leaning administration quickly announced the government's budget deficit for 2011 was likely above 8% of GDP, compared with a 6% forecast by the previous Socialist administration.

In response, the government announced an austerity package looking to lower the deficit by €15 billion ($19.4 billion), including higher taxes and spending cuts, and anticipates more such packages in coming months.

The plan agreed by the Socialists with European Union authorities calls for the budget deficit to drop to 4.4% of GDP this year. That would imply around €40 billion in budget cuts and extra government revenue altogether, assuming that the economy stays flat this year, which is now an unlikely prospect. Even deeper cuts could be made if the economy contracts as the central bank and IMF expect.

In its report, the central bank said it doesn't expect the economy to get back to a positive footing until the first quarter of 2013, and doesn't anticipate any job creation until the second half of next year. Some 22.8% of the Spanish workforce is currently unemployed, a percentage that may rise to 23.4% later this year, the central bank said.

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