Spanish deficit tests Europe’s fiscal treaty

BRUSSELS—THE leaders of 25 European countries on Friday signed a new treaty designed to limit government overspending, but their good intentions were immediately put to the test when Spain said it would miss deficit targets this year to spare itself from austerity overload.

By signing the new treaty, known as the fiscal compact, the leaders hope to achieve closer political and economic integration and longer-term confidence in Europe’s finances.

But the economic reality in the region—record unemployment and a slide back into recession—suggests the leaders need to reconsider their focus on austerity and seek ways to boost growth.

Hours after signing the new pact, Spanish Prime Minister Mariano Rajoy admitted his government’s deficit will be 5.8 percent of economic output this year instead of the 4.4 percent earlier promised to the EU.

The EU’S executive, the European Commission, will be forced to either back off its demands for deficit cuts or sanction Madrid.

The clash illustrates the bind Europe’s leaders are in—having to reduce the debts that created the crisis in the first place while at the same time needing to foster economic growth, without which debt reduction measures will be futile.

“I did not consult other European leaders and I will inform the Commission in April,” Rajoy said. “This is a sovereign decision by Spain.”

Rajoy said he still plans to cut the deficit to 3 percent in 2013, which would put the country back in line with EU rules, and insisted he was committed to austerity as the best way of getting the country back in shape.

Still, Spain’s case will provide an indication of how strict European officials intend to be about enforcing debt reduction in a recession.

A spokesman for the European Commission warned that Madrid, which currently has unemployment higher than 20 percent and a shaky banking sector, could come under renewed mar- ket pressure if it fails to rein in its deficit.

“There is an issue of confidence at stake here,” said Amadeu Altafaj Tardio. He added that the Commission still wants Madrid to provide details on why last year’s deficit was so much higher than expected—and what it plans to do about it this year—before the end of the month.

Europeans leaders at the summit, however, offered few concrete measures to boost economic activity, insisting the new treaty would help growth by increasing confidence in the region and its ability to manage its financial problems.

“It will bring us, as it were, the economic and monetary union that is finally walking on two legs,” said Herman Van Rompuy, the European Council President.

Only Britain and the Czech Republic decided not to sign the agreement, a move that triggered concern over a rift in the 27-country European Union.

Many Europeans have grown weary of the EU and the euro. Two years of painful austerity in the poorer countries have taken their economic toll, while many in the richer countries are getting frustrated over funding the expensive bailouts for Greece, Ireland and Portugal.

Others fear the tighter spending rules will limit governments’ room to maneuver in tough economic times and force German-style fiscal discipline on countries with vastly different economies and cultures. However, the new deficit limits make some exceptions, such as for severe recessions and other unexpected economic circumstances.

Though the leaders’ summit was held under the calmest conditions in financial markets in months, the economic outlook is darkening. Unemployment is at 10.7 percent across the eurozone and several countries are forecast to fall back into recession this year, yet the EU leaders were hesitant to back off austerity.

“We remain in a fragile situation,” German Chancellor Angela Merkel warned. “The crisis is far from over.”