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By Nigel Davies
(Reuters) - Spain's new government will unleash a wave of spending cuts and strengthen economic reforms in the first months of its legislature, moves that will throw the economy back into recession and send unemployment higher before making things better.
Polls show the center-right People's Party storming to an absolute majority in the parliamentary election on November 20, sweeping aside the seven-year-old Socialist government blamed for a deepening crisis and high unemployment.
The task facing the PP will be to assure markets that Spain will continue to do everything to meet its pledges to shrink the deficit.
But a much deeper reform of the labor market, which the PP plans, and even tougher cuts needed to meet deficit targets in the year ahead, will help push the economy into recession, and send the 21.5 percent unemployment rate higher in the short-term.
"The first half of the year will be hard because they will have to cut brutally. It will be the hardest we've seen in the crisis," said Pablo Vazquez, director of economic think-tank
FEDEA.
He believes the PP must take radical moves to make Spain more competitive. Tough labor laws, high severance pay to lay off workers, high regulatory compliance costs and salaries tied to inflation all make Spanish companies less competitive.
"It will be a painful process, but if it's done well Spain will come out of it stronger and it well help the euro zone."
EXACERBATING THE DOWNTURN
He said a short-lived recession was possible over the coming quarters, in line with other euro zone countries, although Spain's economy will be hit further by new cuts and reforms.
Even PP think-tank FAES recognized that Spain's economy will not see decent growth until after 2012 and 2013.
PP leader Mariano Rajoy has warned he will "take the scissors to everything except public pensions, health and education."
Top of the agenda, he said, would be a restructuring of government administrations, including the possible closure of public foundations and works, with a freeze on hiring too.
The economy stagnated in the third quarter and many analysts now forecast a contraction by year's end as a global downturn bites into exports that had supported a feeble recovery.
In 2008 Spain's economy fell into a recession that was fiercer than that in other European countries thanks to the bursting of a housing and construction boom. Unemployment soared from 8.6 percent at the end of 2007 to more than 21 percent currently.
For a decade previously Spaniards had piled into a booming housing sector in a binge fueled on cheap bank credit at a time when low euro zone interest rates stimulated prices in southern European countries.
Banks also gobbled up large swathes of property and then got dumped with even more when the crisis forced land developers and Spanish families to hand over the keys when they could not keep up with payments.
The PP has said it will intensify a restructuring of the banking sector to ensure markets have confidence in the country's banks, and capital flows again to businesses.
The Socialist government and the country's 17 autonomous regions got carried away with a spending spree too, pushing up the public deficit to 11.2 percent of economic output in 2009.
HEFTY CUTS, MORE REFORM TO COME
With analysts predicting some slippage of the government's public deficit target this year of 6 percent of gross domestic product, even steeper cuts next year are inevitable if an optimistic target of 4.4 percent in 2012 is to be met.
The Socialists constructed the target on a forecast for the economy to expand by 2.3 percent next year, but now analysts see the economy growing by only half that much.
While Rajoy has ruled out cuts to education and the health system, other PP leaders have made cuts in those areas in autonomous regions they control, sparking protests.
"The new government will need to explain clearly that the measures they take will not solve things in the short-term, but they would help the economy recover in the medium term," said Miguel Cardoso, chief economist for BBVA Research.
Both parties have largely avoided explicit references to the deepening euro zone crisis while on the campaign trail, preferring to focus on the primary concern of Spanish voters: unemployment.
But Rajoy's economic team believes cuts will generate market confidence and bring down government borrowing costs, which have shot up close to unsustainable levels. That in turn will open up credit between banks and businesses and spur economic growth.
Cardoso said reforms should be carried out to help stimulate business growth, by reducing the costs of opening a business.
Indeed, the PP has said it will cut business tax by 5 percentage points and encourage profits to be reinvested in to modernizing businesses. A PP win is viewed largely positively by business groups and the small to mid-size companies that form the backbone of the economy.
"A likely PP win, given the party's past in helping business, gives us a slight hope of a change in the economic cycle. But job losses, with close to five million out of work, will hit family spending even harder and make it difficult for small companies to find profitable areas to grow," said Inigo Ibanez, head of Censor, a small consulting business in Madrid.
Labor unions are skeptical that cuts are the answer, and say European capital Brussels is dictating policy for Spain.
"From what the PP has announced they will do so far it is nothing more than the continuation of policies that are leading Europe toward disaster," said Javier Doz of Spain's largest union federation CCOO.
He said a radical change would need to be seen to stimulate growth, but wants the PP to force businesses to commit to hiring in exchange for wage moderation and a weakening in union power to negotiate wages.
(Editing by Angus MacSwan and Myra MacDonald)
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