Spain's budget deficit will only fall to 6.3 per cent of GDP this year as the eurozone's fourth largest economy shrinks faster than previously expected, the European Commission said yesterday.
The Commission had previously told Spain to reduce its deficit to 5.3 per cent by the end of 2012. But it will instead propose today to EU finance ministers that the target be relaxed. The Commission has also raised its 2013 deficit target for Madrid to 4.5 per cent and for 2014 to 2.8 per cent.
Spain has succumbed to a double-dip recession with output contracting by 0.4 per cent and 0.3 per cent respectively in the last two quarters. The European Commission expects the Spanish economy to contract by 1.8 per cent by the end of 2012.
The move came as European finance ministers gathered in Brussels to hammer out an agreement on recapitalising Spain's banks.
In June, Madrid requested a €100bn (£80bn) bailout from the EU for its bust banks. And European leaders last week agreed that the European bailout funds will be allowed to recapitalise European banks directly, taking some of the pressure off Spanish Prime Minister Mariano Rajoy.
But Madrid's 10-year borrowing costs jumped back above the 7 per cent danger level in trading yesterday as investor fears grew that the direct recapitalisations of Spanish banks might come too late to safeguard the solvency of the Spanish state, necessitating a full bailout.
Mr Rajoy is poised to unveil a third wave of austerity measures in a bid to avoid a full-scale bailout. He is mulling a fresh tax grab on products like food, gas and water which currently carry a reduced rate of VAT.
The president of the European Central Bank, Mario Draghi, said the decision taken in Brussels last month to create a European banking union was a "major step". He called on the Commission to bring forward a "strong proposal" to make it a reality.
The ECB disappointed financial markets last week, despite cutting interest rates to their lowest level in the history of the single currency, because Mr Draghi ruled out any further direct help for struggling European states like Spain or Italy.
Mr Draghi reiterated that the central bank could not be expected to solve the crisis on its own. "Effective crisis resolution needs bold actions by central banks, but it also needs bold actions by other policy actors, notably governments" he said.