Spain set itself a softer deficit target for 2012 than originally agreed under the euro zone's austerity drive, putting a question mark over the credibility of the European Union's new fiscal pact.
Prime Minister Mariano Rajoy insisted he was acting within EU guidelines with the more lenient figure because it would still hit the European Union public deficit goal of 3% of gross domestic product (GDP) in 2013.
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Spain's new 2012 target of 5.8% of GDP, was more realistic than the original goal of 4.4% but still demanding, he said.
"I'm backing austerity and aim to reduce the deficit from 8.5% to 5.8%; that's significant austerity," he said at the end of an EU summit in Brussels on Friday.
The announcement cast a pall over an agreement for tougher debt rules in the bloc. All but two of the EU's 27 leaders signed up to a 'fiscal compact' on Friday that commits euro zone countries to balancing their budgets over the medium-term.
Spain has already cut spending sharply and adopted economic reforms to avoid getting sucked deeper into the euro zone debt crisis that has prompted bailouts for Greece, Ireland and Portugal.
German Chancellor Angela Merkel and European Council President Herman Van Rompuy said that for euro zone credibility to endure there should not be any flexibility on fiscal targets for countries in economic difficulties.
Rajoy said his move would not spook markets, but Spain's long-term cost of borrowing rose after the news, bringing it to parity with Italy for the first time since August, as investors fretted Madrid may have to sell more debt than planned.
Spain is emerging as a test case of whether Europe is willing to ease fiscal rules that heap more cuts on member states grappling with stunted growth, high unemployment and the threat of growing social unrest.
The government said on Friday that Spain's economy will shrink 1.7% this year, matching the outlook from the International Monetary Fund.
Rajoy's announcement made economic sense for Spain but Madrid and Brussels should have been able to negotiate a way out of the clash, said Thomas Klau, head of the European Council on Foreign Relations in Paris.
"It's the first step for undermining the credibility of a system which has not even had time to accumulate any credibility capital," Klau said, referring to the fiscal pact.
Rajoy said he did not bother lobbying other European leaders at Friday's summit.
"I'm not going to tell the other presidents or heads of state about the deficit figure that will be included in our budget. I don't have to. It's a sovereign decision. I'll tell the (European) Commission in April," Rajoy said.
The gambit will force the EU to decide whether or not to punish Spain under new austerity rules.
"It's a dangerous game because you jeopardize the legitimacy of the whole (fiscal stability) process," said Antonio Barroso, a London-based political analyst with the Eurasia Group. "Either he knows eventually they will make the objectives more flexible, or he's very brave and prefers to get the sanction."
Rajoy, known as a cautious public administrator, campaigned on strict adherence to the 4.4% target in an election campaign which ended with an overwhelming majority for his centre-right party in November.
But Spain's economic situation has deteriorated since then.