By Nigel Davies

MADRID, Aug 20 (Reuters) - Spain's leftist government will
likely make good on its promise to pass the toughest budget in
15 years by December, reassuring markets at the cost of
concessions to regional autonomy, particularly in the northern
Basque country.

As Spain struggles to emerge from recession and fend off
worries over its ability to fund its debt, Socialist Prime
Minister Jose Luis Rodriguez Zapatero has promised huge spending
cuts while he tries to keep his unpopular government in power
until 2012 elections.

The budget, which must be presented to lawmakers by the end
of September, will contain 10 billion of the 15 billion euros
($19.25 billion) of spending cuts promised this year and next to
convince Spain's creditors it can deal with a swollen public

Having lost the support of the other main leftist parties,
Zapatero will have to lean on smaller regional groupings for
their support in order to pass the budget.

That will entail months of tight negotiations, with the
Basque nationalist party offering its support, but only in
return for more political self-governance and a drive for
further reforms. Other smaller parties such as Coalicion Canaria
may also present similar demands.

Analysts do not see such demands posing a major problem for
the government. But they say ministers are still walking a
tightrope between withdrawing so much impetus from the economy
that it grinds to a halt -- and fending off charges of the sort
of public overspending that propelled Greece into crisis.

"Spain ... needs to show markets that it will deliver on the
fiscal side," said Gilles Moec, economist at Deutsche Bank.

"But the risk is that more measures could prove a shock to
growth. For now Spain has got the right balance."


Ministers have underlined the target of cutting the deficit
to 6 percent in 2011 from 11.2 percent in 2009 is
"unconditional", even if a weak economy may make that a tough
task and force the government to take additional measures.

This year's budget has already implemented a third of the
proposed cuts, which slash some 6.4 billion euros off public
works. The initial plan in May also outlined a cut in public
spending in 2011 to 122 billion euros from 132 billion.

With leftist parties and unions supporting a Sept. 29
general strike against cuts in wages and pensions, and no
support from the rightist Popular Party and Catalan CiU party,
the Socialists' need votes from the Basque nationalists (PNV).

"We're not going to negotiate over small change," Member of
Parliament Inaki Anasagasti told Reuters, saying he wants
further autonomous powers for the Basque regional government.

"If you want our support, then let's talk about the Basque
constitution. Let's talk about reducing the number of
ministries. Let's talk about structural reforms..." he said.

Spain is already one of Europe's most decentralised states,
with the central government controlling only about 20 percent of
national public spending, while autonomous regions and local
councils control about half, making their cooperation essential
in any spending decisions.

The Basque ETA movement is held responsible for the deaths
of more than 800 people in its 40-year campaign to carve out an
independent state in northern Spain and southwestern France.

Anasagasti says he will demand the transfer of powers to the
Basque region to be speeded up, closure of at least three
unneeded central government ministries, and a reduction in the
number of vice-presidencies from three to one.

He backed, however, the cutting of regional spending flab
and the Basque and Catalan parties, who often play kingmaker
roles, know that stalling the budget could hurt them by forcing
a no-confidence vote that would return power to a Popular Party,
which is less friendly to their regional movements.

"There were signs before the summer that the government
would be able to reach an agreement with the Basques," said
Emilio Ontiveros, chairman of economic consultancy Analistas
Financieros Internacionales.


Spain is again being watched closely by markets due to a
slowdown in growth that will eat into state revenues, but also
because of a small but symbolic move to restart some of the
projects shelved under austerity measures.

After a brief spike in Spain's country risk -- a widening of
the spread between Spanish 10-year bonos and German bunds -- a
string of ministers rushed to underline this month that the 6
percent deficit target for 2011 was not in question.

"Any decision to increase government spending must be
weighed carefully," said Tullia Bucco, economist at UniCredit.

"This is especially the case of Spain given that the
ambitious 2011 deficit target and too optimistic growth
forecasts do not leave the government much room for manoeuvre."

Madrid also raised value-added tax (VAT) by two percentage
points in July, but infrastructure minister Jose Blanco in
mid-August opened the possibility of further tax rises to come,
saying Spain's tax take was well below the European average.

While economy minister Elena Salgado said higher taxes were
not necessary to meet deficit targets, there has been talk among
analysts of rises to goods such as alcohol, tobacco and fuel, in
part to finance any reopening of infrastructure works.

European Central Bank Executive Board member Jose Manuel
Gonzalez-Paramo has also warned the government was being too
optimistic over its growth forecasts. [ID:nLDE67B10F]

The official outlook is for 1.3 percent economic growth in
2011 and 2.5 percent the year after, figures the International
Monetary Fund doubts will be possible given unemployment at 20
percent will hinder strong domestic growth for some time.

(Additional reporting by Manolo Ruiz; editing by Fiona Ortiz
and Patrick Graham)