Exclusive: Spain plans deeper pension reform to meet EU demands

Spain will soon intensify pension reforms, possibly accelerating an increase in the retirement age and restricting index-linking of pension payouts to meet European Union demands to fix the country's troubled public finances, Spanish officials said.

Removing an automatic annual inflation adjustment for state pensions and speeding up the phasing in of a higher retirement age are long-standing European Union demands that Spain must meet in order to tap international aid to bring down borrowing costs and fix its stricken economy.

A senior Spanish government source told Reuters the reform, aimed at getting a grip on 100 billion euros a year in pension costs, or 10 percent of gross domestic product, would be presented to lawmakers in the next few weeks, possibly in early 2013.

The source said the government would propose steps to accelerate the increase in retirement age to 67 from 65, currently scheduled to take place over 15 years. Three other Spanish officials corroborated the plan.

The government is also considering removing the annual inflation-linked pension hike or, at least, applying conditions so that pensions do not rise when the economy is in recession or when the public deficit exceeds a certain level.

The four sources cautioned the reform was still being discussed at cabinet level -- although talks are at an advanced stage -- and that the only firm agreement so far was on a set of new rules to make early retirement more difficult, already flagged by the government in September.

The Socialist opposition is not expected to block the new set of rules, the sources said. Rajoy can in any case count on a strong majority in parliament to pass the law.

"The idea is to introduce more flexibility into the system. For instance, by making it possible not to adjust pension payments in the case of a recession or a deficit, or when you have liquidity tensions," the senior government source said.

"We also want to introduce a more automatic link between higher life expectancy and changes in the retirement age," the source said.

Prime Minister Mariano Rajoy is considering when to request European aid that would trigger a European Central Bank bond-buying program to bring down borrowing costs that have soared in the euro zone debt crisis.

In order to meet tough EU-agreed deficit goals, Rajoy was forced last month to cancel the annual inflation adjustment for pensions, a move with a high political cost in a country where 20 percent of the population, or 9 million people, is retired.

Breaking a campaign pledge he opted to instead raise pensions by 1 percent in 2013, or 2 percent for the very lowest pensions. This way, the government saved around 3.8 billion euros that it would have had to spend to raise pensions in line with inflation of about 2.9 percent.

Discussions now center on breaking the principle of an inflation link more permanently by building in legislative caveats, rather than looking at it on an ad hoc basis.

UNSUSTAINABLE

One of the Spanish officials said the government was keen to make structural reforms to the pension system as it had become clear over recent years that it was not sustainable.

"Cutting the link between inflation and pensions is being discussed. It is the third year in a row we've had to take an 'extraordinary' decision (not to raise pensions) and the rule does not make much sense anymore," the official said on condition of anonymity.

Rajoy performed especially well among pensioners when he was elected in a landslide last year and his first move after taking office was to hike pensions after his predecessor Jose Luis Rodriguez Zapatero froze them in May 2010 when Spain entered the euro zone debt storm.

Zapatero also passed a law to add two years to the retirement age by 2027. Rajoy's People's Party, then in opposition, voted against the change.

Spain is by no means alone among European countries struggling to overhaul pension systems that have become unsustainable due to higher life expectancies.

But Spain's public pension system is particularly vulnerable because the country has the highest unemployment rate in the European Union at 25 percent, meaning fewer workers are making tax contributions to maintain it.

As the number of people contributing to the state pension system has fallen to its lowest level in a decade - more than 2 million Spaniards have lost their jobs and stopped paying into the system - Rajoy has been left with little choice.

The government tapped 4.4 billion euros from an insurance fund to make July and August payments to pensioners and last month passed a law to tap the pension reserve fund to ease liquidity tensions over the next two years.

EU DEMANDS

The reform plan is also a long-standing demand from the European Union. The International Monetary Fund and European Central Bank are also pushing Spain to sever the link between pensions and inflation.

The four Spanish officials said they were aware of the EU demands but insisted it was not the main factor that triggered the new reform.

However, a European official, also speaking on condition of anonymity, said the European Commission had insisted on the reform at recent regular meetings with the Spanish authorities.

"We have specific demands on measures to increase the retirement age. In July, the government announced a series of steps but it lacked details," the official said.

"We would welcome clear steps and details. For instance, increasing by one or two months every year the planned rise in the retirement age, fixing the minimum early retirement age at 63 instead of 61, implementing penalties for early retirement or installing an automatic revision of the retirement age linked to life expectancy," the official added.

He however said no specific demand had been formulated recently on delinking inflation and pensions because there were conflicting voices within the Commission on the issue.

The Commission recommended in a July report that Spain make its pension system more sustainable without specifying how.

In November, it said Spain had done enough to rein in its public finances in 2012 and 2013 but asked the country to spell out new economic reforms for 2014 and beyond by next February.

(Editing by Fiona Ortiz)