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Spain's debt pain brings a backlash against austerity

Demonstrators shout slogans condemning recent austerity measures announced by the Spanish government during a demonstrations in Madrid, Spain, Wednesday, July 11, 2012. Spain's government imposed more austerity measures on the beleaguered country Wednesday as it unveiled sales tax hikes and spending cuts aimed at shaving euro 65 billion ($79.85 billion) off the state budget over the next two and a half years.

Emilio Morenatti/AP Photo

A bloody clash between protesters and police in Spain highlights the growing pushback against the wrenching government austerity under way in much of Europe.

Police fired rubber bullets at protesting miners and thousands of supporters in the heart of Madrid on Wednesday, sending at least six to hospital, as Prime Minister Mariano Rajoy announced another dose of tough economic medicine.

The protests – the first large-scale demonstrations to hit the Spanish capital since the crisis began – underscores the growing resistance facing many European governments as they struggle with mounting debt and a downward economic spiral.

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Spain's €65-billion package promises sharply higher sales tax, steeper energy bills and lower wages for many over the next 2 1/2  years. It also promises a longer and deeper recession – and therein lies the quandary for Europe's most heavily indebted countries. Tough budget measures are destabilizing already weakened economies and delaying a recovery.

As the Prime Minister was outlining the latest emergency measures, thousands of miners upset at subsidy cuts to coal producers marched into Madrid, joined by thousands of sympathetic locals.

The miners worry that budget cuts will lead to mine closings and thousands of layoffs. Ordinary Spaniards are also growing weary of seemingly endless budget cuts and tax hikes.

Mr. Rajoy acknowledged his unease, calling the measures "not pleasant, but they are necessary." He blamed changed circumstances for reneging on a campaign promise and hiking the value-added tax to a punishing 21 per cent from 18 per cent.

"We are trying to stick to a path that is not easy, short or comfortable, but we cannot avoid it. This is the only one that leads to recovery," Mr. Rajoy told lawmakers in the Spanish parliament.

The moves will hit consumers especially hard in a country already reeling from a flight of private investment, a real-estate meltdown and steep unemployment.

Spain's economy is expected to shrink 1.7 per cent this year as the country endures its second recession since 2008. The jobless rate is already the worst in the 17-member euro zone at nearly 25 per cent. More than half the country's under-25s are out of work.

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"It's a climate where private investment isn't happening and where money isn't coming from the public sector," remarked Gordon Betcherman, an economist at the University of Ottawa and a former World Bank official. "It's hard to imagine that unemployment won't go even higher."

Compounding the continent's woes, Europe is facing years of hardship. "This is such a long haul. This is not your normal cyclical downturn," Prof. Betcherman said.

Spanish officials are predicting near-zero economic growth next year. Private-sector economists fear worse – contraction of 1.4 per cent as austerity takes a huge bite out of the economy.

Spain badly overshot its deficit target this year. On Monday, euro-zone finance ministers agreed to relax the goal to 6.3 per cent of gross domestic product this year, from an initial target of 5.3 per cent.

But even that mark could be tough to achieve. Spain rang up a deficit just shy of 9 per cent of GDP in 2011.

Canada's federal deficit is expected to hit 1.2 per of GDP this year and 0.5 per cent in 2013.

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Spain is hardly unique. Other euro-zone countries already in recession, including Italy, Portugal and Greece, are facing a similar austerity dilemma. The more they clamp down, the more their economies shrink, worsening their fiscal problems.

In the Portuguese capital of Lisbon on Wednesday, doctors in white coats took part in protest marches and a national strike over cuts to the health budget. The Portuguese Health Ministry said 400,000 medical appointments and nearly 4,500 operations were cancelled.

Experts argue that Spain's tax hikes could make austerity less palatable to Spaniards. Anders Aslund, a senior fellow at the Washington-based Peterson Institute for International Economics, said countries should focus more on spending cuts than tax hikes.

"People do not want to pay more for less public services," Mr. Aslund said. "It's much easier to sell to the population that the government is trying to trim itself with belt tightening … and it also drives structural reform."

Mr. Rajoy and the Spanish government are facing growing pushback from Spaniards, fed up with the combination of budget cuts and higher taxes.

Spain and many other euro-zone countries have little room to manoeuvre and few good options.

Spain, for example, is attempting structural reforms, budget cuts and tax hikes – all simultaneously. In addition to the VAT hike, Mr. Rajoy announced tax hikes for heavily subsidized utility companies, reduced jobless benefits for younger workers and a 7-per-cent pay cut for federal workers.

Doing nothing isn't an option. In recent months, Spain has faced upward pressure on borrowing costs as investors fret about the country's mounting economic problems and worsening financial condition.

Until Spain puts its finances on a sustainable path, investors will demand a steep premium to lend it more money.

Borrowing costs eased a bit Wednesday as investors reacted favourably to the austerity package. The rate on 10-year government bonds fell 16 points to 6.62 per cent. In recent weeks the yield has neared the 7-per-cent mark – a level analysts said Spain can't afford.

With a report from Reuters

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