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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 deficit.

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 PNV 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."

Division

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.

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.

Tough balance

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.

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.