US embassy cable - 05MADRID3684

UNCLAS SECTION 01 OF 02 MADRID 003684 
 
SIPDIS 
 
SENSITIVE 
 
EUR/WE FOR GARY CLEMENTS 
STATE PASS TO TREASURY - TRACI PHILLIPS 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, SP 
SUBJECT: SPAIN UNVEILS BUOYANT 2006 BUDGET 
 
REF: MADRID 3460 
 
1. (U) SUMMARY: Second Vice President and Minister of Economy 
Pedro Solbes Mira presented the Socialist government's 
general state budget to Congress on September 27. The budget 
prioritizes increasing productivity and reducing public debt. 
The five pillars of the budget are research, development, and 
innovation (R&D&i), infrastructure, education, Official 
Development Assistance, and public services. Solbes forecast 
a budget surplus of 0.2% of GDP, and a 7.3% increase in 
government spending. The budget assumes growth of 3.3% and 
inflation of 2%.  The budget takes risks by assuming that 
interest rates will hold at 2% and that the average crude oil 
barrel price will be 55 USD. END SUMMARY. 
 
Introduction 
------------ 
 
2. (U) Second Vice President and Minister of Economy Pedro 
Solbes Mira presented the Socialist government's draft budget 
to Congress on September 27.  The stated goals of the overall 
budget are to reduce public debt and to increase 
productivity, goals not unlike those of the 2005 budget. 
Solbes also announced a five pillar strategy for 
prioritization of spending. While other EU member states 
struggle with budget deficits, Solbes forecast a small budget 
surplus of .2% of GDP for 2006. The small surplus is possible 
due to a 9.8% increase in direct tax revenues and social 
security contributions. The increase in contributions is due, 
in part, to an immigration amnesty program for more than 
600,000 illegal immigrants that has brought a large part of 
the underground economy out into the open.  As a result, 
government revenues are forecast to be up 8.4%. Government 
spending is slated to increase 7.7%. 
 
Approval Process 
---------------- 
 
3. (U) Spanish law requires approval of the budget from both 
houses of Congress prior to implementation. Solbes' budget 
must be debated within the Chamber of Deputies, a process 
during which amendments can be made.  Following this, the 
budget will be sent to the Senate for its own debate and 
approval process.  The Senate will then send the budget back 
to the Chamber of Deputies for final approval.  If the budget 
proceeds through both houses of Congress according to the 
government's schedule, it should receive final approval 
during the last week of December. Spending limits outlined in 
the 2005 budget will be carried over into 2006 if the budget 
is not approved by the end of the year. 
 
Winners 
------- 
 
4. (U) Solbes' 2006 budget has a basic five pillar strategy. 
The first is improved productivity through greater investment 
in research, development, and innovation (R&D&i). Funding 
destined for R&D&i is to be increased by 29.7% for a total 
investment of 6.5 billion euro.  In reality, only 4.8 billion 
euro of this amount will go to civil R&D&i, with the rest 
allocated to defense research, contributing to criticism 
about the GOS' commitment to support an increase in R&D&i. 
Total spending will still account for only slightly over 1% 
of GDP, far from its goal of 2% by 2010. 
 
5. (U) The second pillar calls for an increased investment in 
infrastructure in order to further improve productivity. 
Plans are to increase spending 12.4% over 2005, for a total 
of 12.8 billion. The increase in the infrastructure 
allocation will partially compensate for the loss of EU 
structural funds that contributed to the construction of 
Spain's modern road network. 
 
6. (U) The third pillar, education, will receive a 16.6% 
increase, the majority of which will be allocated to 
secondary education.  Prime Minister Zapatero had promised 
that education would be the "star" of the 2006 budget.  The 
debate continues as to whether or not the proposed increase 
will be sufficient to address the concerns of the current 
education administration. 
 
7. (U) The fourth pillar is an improvement in the quality of 
public services, which will receive a 9.9% increase in 2006. 
The main priority within this pillar is a reorganization and 
modernization of the Justice department, which will receive 
12% more over 2005.  Salaries in the armed forces and 
judiciary will also be raised 8% next year, supporting the 
government's hopes to increase armed forces recruitment 
levels. 
 
8. (U) An increase in Official Development Assistance (ODA) 
is the final pillar.  Direct ODA spending is proposed to 
dramatically increase by 57.1% to a total of 681.46 million 
euro.  Total ODA spending would account for .35% of GDP. See 
reftel for more detailed information on the proposed ODA 
increase 
 
Losers 
------ 
 
9. (U) Most programs previously funded will not experience a 
decrease in net spending in 2006.  However, a number of 
organizations and public entities will lose funding, 
including: the Spanish Patent and Trademark Office (-18.8%); 
the Gerencia de Infraestructuras y Equipamiento de Defensa, 
the government agency that manages the railways and defense 
equipment, (-15.6%); the Nuclear Security Council (-5%); the 
National Statistics Institute (-2.0%); and other 
miscellaneous state foundations (-15.11%).  Miscellaneous 
economic programs will also lose 12.1%. Two autonomous 
regions will also lose funding in 2006, the Baleares 
(-10.12%) and the Basque Country (-3.66%). On an interesting 
note, in spite of Solbes' proclaimed goal of reducing public 
debt, funding to pay off the debt is reduced in the 2006 
budget by 9.6% from 2005. 
 
Assumptions in the Budget Process 
--------------------------------- 
 
10. (U) The budget is based on 2% inflation and a predicted 
3.3% economic growth rate for 2006, a rate that remains much 
higher than the EU average.  A somewhat more risky assumption 
in the budget is that interest rates will remain at 2%, which 
is unlikely given recent statements by the European Central 
Bank. Further, the budget assumes an average crude oil barrel 
price of 55 USD, well below the current market rate. In fact, 
soaring oil prices led to a near doubling of Spain's current 
account deficit in 2005 to 33 billion euro or 7.5% of GDP. 
 
Political Context 
----------------- 
 
11. (SBU) Solbes has been vocal in stating that this year's 
budget is the first true reflection of the PSOE socialist 
government's priorities, claiming that the 2005 budget was 
influenced by decisions made by the previous conservative PP 
government.  The socialists are likely to gain from a 
decision to hold both corporate and personal income taxes 
steady, with the caveat that ceilings on brackets will be 
raised by 2% to allow for inflation. 
 
12. (SBU) Catalonia will be one of the main beneficiaries of 
spending on infrastructure.  The perception that the PSOE 
government is placating the Catalan regional government in 
order to avoid further political separatism may create 
resentment amongst the other regions. However, the socialists 
are a minority government and must rely on the support of 
smaller parties such as the left-wing Catalan ERC party in 
Congress in order to guarantee approval of the draft budget. 
Nonetheless, the Catalan regional government maintains that 
is being shortchanged in per capita spending when compared 
with the autonomous community of Madrid. 
 
Economic Context 
---------------- 
 
13. (U) Spain is in its 10th year of uninterrupted economic 
growth boosted by improved fiscal management. Low interest 
rates accompanied the arrival of the euro which has also 
fueled cheap credit and a housing and construction boom. 
Property prices have risen by more than 150% since 1997. 
Fears linger that the overpriced housing market, coupled with 
the growing debt burden of Spanish families, may lead to a 
decline in economic growth.  Spain is also losing its 
competitive edge, as unskilled manufacturing jobs migrate to 
Eastern Europe and Asia, and tourism faces the increasing 
popularity of cheaper foreign destinations. 
AGUIRRE