By Andrew Hay and Andras Gergely
MADRID/DUBLIN, April 23 (Reuters) - Spain could be sliding towards harsh budget cuts like those forced on another former euro zone high-flyer Ireland.
Concern about Ireland's deficit and exposure to bank losses pressured its government to slash spending and hike taxes this month to reassure investors of its long-term solvency.
Although Spain has just launched a bank restructuring plan, it has nothing like Ireland's exposure to bank liabilities nor its dependence on housing-related revenues. This relatively favourable position means bond markets are giving Spain more freedom to spend -- but therein could lie its greatest risk.
Spain's Socialist government may be given enough fiscal room to double its debt level and build a double-digit deficit, then be unable to correct imbalances as growth fails to rebound.
In such a scenario, rating agencies could turn on Spain and impose the same kind of downgrades that have hit Dublin, which launched what critics dubbed "the budget from hell".
"You can think of Spain as a slow-burn situation. If they don't get the right policies over a number of years, they'll get themselves into quite a mess over public finances," said BNP economist Dominic Bryant.
Spain is the only one of the world's eight largest economies that will suffer two consecutive years of contraction in 2009 and 2010 after the collapse of its domestic housing boom coincided with the global crisis, according to Fitch Ratings.
Unemployment in Spain is rising faster than in any other developed country and is widely expected to top 20 percent, or 4.5 million, in 2010.
DIGGING A FISCAL HOLE
On the eve of the global crisis, Spain and Ireland seemed in good fiscal shape with balanced budgets and low public debt after running the euro zone's two biggest ever property booms.
In the space of 18 months, the Spanish and Irish governments have had to take responsibility for the collapse of housing and credit bubbles funded by their private banks.
Spain launched one of Europe's biggest fiscal stimulus packages, paid for by public borrowing, and Ireland could see a massive jump in national debt due to its efforts to cleanse banks of tens of billions of euros in risky assets. Most analysts say Ireland's government has been forced to punish its economy to save banks, a situation Spain must avoid.
"I am angry and disillusioned at the price we all have to pay for the failures to manage the economy," wrote Jim Power of financial services firm Friends First after Ireland's emergency budget was unveiled.
Spanish Prime Minister Jose Luis Rodriguez Zapatero has made no secret of his aim to keep up discretionary spending and compensate for a collapse in construction, tourism, and car sectors that formerly drove half of Spanish growth.
He fired Economy Minister Pedro Solbes this month after he said Spain had to respect EU deficit limits and appointed his public administration chief to speed up fiscal stimulus equivalent to nearly 5 percent of gross domestic product.
Spain's government accuses Bank of Spain Governor Miguel Angel Ordonez of alarmism for warning the social security system could enter deficit and Spain must launch structural reforms, the need for which the IMF also emphasised on Wednesday.
In the case of Ireland, pressure from the European Commission and markets helped convince Dublin to place a levy on public servants' pensions to improve social security accounts.
"If you look at a country like Spain it just shows how politically difficult it is to push through these kinds of decisions," said Rossa White at Dublin-based brokerage Davy.
Analysts in Spain recognise the importance of state stimulus, but say Zapatero is doing little to change a crumbling, construction-based economic model.
"The government does not want social conflict, it doesn't want problems, it just wants this crisis to end as soon as possible, and it's going to leave us indebted," said Juan Carlos Martinez Lazaro of the Madrid-based IE business school.
POTHOLES AND RUBBISH
Others expect Zapatero to be forced into drastic spending cuts next year as government income slides, the mood sours on Spanish debt in crowded bond markets and the euro zone's No.4 economy proves unable to stage an export-led recovery.
"We are going to see potholes in highways and rubbish piling up in cities because debt is going to swell and we are going to see brutal spending cuts in the 2010 budget," said Santiago Nino Becerra at Barcelona's Ramon Llull University, who forecasts Spanish unemployment will rise as high as 26 percent next year.
Ratings agency Fitch said in a report last month sovereign lenders with its top "AAA" rating, Spain among them, were at risk of being downgraded if they could not cut swelling public debt and budget deficits over the medium term.
Standard & Poor's stripped Spain of its AAA rating in January over fears of a significant deterioration in public finances and a decline in growth prospects. Fitch and Moody's have so far held ratings and kept stable outlooks, although Fitch sees Spanish government debt next year nearly doubling to 65 percent of gross domestic product from 36 percent in 2007.
Fitch head of global economics Brian Coulton does not see an outright collapse in Spain's fiscal revenues, along the lines of the steep decline seen in Ireland, and says its exporters are keeping a larger global share than competitors in France.
"We expected Spain to go through rebalancing of low trend growth, with the external sector mitigating the adjustment," said Coulton. "The rebalancing is going to be more difficult because of the global recession." (Editing by Stephen Nisbet)