Europe will grant Spain an extra year to reach its deficit targets after it outlines further budget savings to finance ministers meeting in Brussels, diplomats said on Monday.

Although no final decision is expected at a Monday meeting of euro zone finance ministers on a bailout of Spain's banks, a wider gathering of EU finance chiefs on Tuesday is set to ease a debt goal that has pressured Madrid to make punishing cuts that are exacerbating a recession.

“Spain's budget consolidation targets will be adjusted to give it an extra year,” said one of the diplomats.

“This is not a unilateral move. Spain needs to make the necessary cuts to reach that goal and this will be discussed on Tuesday at the Ecofin (meeting of ministers). I expect the extra year to be granted.”

Officials said the European Commission will propose a new deficit goal of 6.3 percent of economic output for this year, 4.5 percent for 2013 and 2.8 percent for 2014.

Madrid had been due to reduce its budget deficit to 3 percent of gross domestic product by the end of 2013. But a deep recession is putting that beyond reach.

The Commission will make the proposal to the EU's finance ministers on Tuesday, who would then have to agree. At that point it would become binding, two officials told Reuters.

Economy Minister Luis de Guindos will spell out to the meeting his government's plan for a package of up to 30 billion euros over several years through spending cuts and tax hikes that are due to be announced this Wednesday.

A source close to the Spanish government said 10 billion euros of cuts would come this year and that the measures would include a VAT hike, reduced social security payments, reduced unemployment benefits and changes to pensions calculations.

A decision on the full details of a bailout of up to 100 billion euros ($125 billion) Spain has requested for its banks is also due shortly.

A Spanish government source said it would sign a memorandum of understanding on Monday in Brussels regarding the rescue, which would be followed on July 20 by a full loan agreement. As part of that, it will agree to create a single bad bank to house toxic assets from its banking sector.

While Madrid strives to cut its debts and shore up its struggling banks, it has consistently pleaded for help to get down its borrowing costs. Spanish 10-year government bond yields above seven percent are not sustainable indefinitely.

“At this moment the only institution that has enough money to act is the ECB,” Spanish Foreign Minister Jose Manuel Garcia-Margallo said at a conference. “For that reason, the ECB should intervene in markets, it should start massive purchases of public debt so that speculators understand that they will lose their bets against the euro.”

The European Central Bank has proved markedly reluctant to revive its bond-buying programme.


Alongside Spain, euro zone ministers will also be confronted with the need to decide on a new structure for cross-border banking supervision, how to use euro zone bailout money, aid to Cyprus and whether to grant concessions to Greece, which has admitted it is missing its bailout programme targets.

A key part of a plan agreed by euro zone leaders at a summit last month is to give the ECB a central role in supervising banks, which would then allow the permanent rescue fund - the European Stability Mechanism (ESM)- to recapitalise banks directly instead of via governments.

ECB President Mario Draghi testifies to the European Parliament before ministers meet.

Leaders want to break the link between banks and sovereigns by not lumbering governments with debts for rescuing their lenders, making it harder for them to borrow.

They agreed to remove the ESM's preferred creditor status when it lends to Spain, to calm investors who were worried they would not be repaid money they had already lent.

They also decided that the ESM and the euro zone's temporary bailout fund, the EFSF, can buy euro zone bonds at auction and in the open market to lower borrowing costs, with some conditions attached but without a full programme.

The ESM is due to start operating during the European summer, but at least for now, countries will need to provide guarantees in return for bank aid it gives, according to one euro zone official who is involved in preparing the Eurogroup.

A spokesman for the European Commission said this would change once a new supervisor for banks is in place, which is expected next year.


Much depends on the ECB's crucial role as supervisor, which will need to be grounded in European law. It falls to the European Commission to propose such legislation, which is not expected until at least September.

Despite the obstacles to the broad package outlined by leaders, the range of measures agreed allow some short-term action, although there is vocal opposition from the Netherlands and Finland.

Helsinki insists that there was no agreement on bond-buying by the ESM in secondary markets at the leaders' summit.

Coordinating euro zone finance ministers has been the job of Luxembourg Prime Minister Jean-Claude Juncker since 2005, but his terms ends on July 17 and ministers are due to discuss his successor on Monday. However, confusion over who that is likely to be means his term may be extended.

Ministers will discuss the findings of the “troika” of the European Union, the European Central Bank and International Monetary Fund from their first mission to Greece since the June 17 election. Another mission is due to return later in July. - Reuters