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By Julien Toyer and Robin Emmott
MADRID/BRUSSELS (Reuters) - Spain acknowledged that its economy would shrink more than initially expected in 2013 and its budget deficit would be higher than promised, but the European Union gave it more time to bring the shortfall back down to bloc limits.
Prime Minister Mariano Rajoy, who was a keen advocate of austerity in his first year in power, has tried since February to find a middle way in the argument over Europe's economic future between pro-austerity and pro-growth camps.
Officials began on Friday to sketch out a reform plan aimed at returning Spain to growth but details remained thin, with the government saying there was no need to pass major new structural measures, tax hikes and spending cuts to meet the new targets.
The economy is set to contract 1.3 percent this year from a 0.5 percent recession initially expected, the government said. It would return to growth in 2014.
The public deficit would now reach 6.3 percent of economic output from an earlier 4.5 percent estimate. This means that, with a deficit at 7.1 percent of GDP in 2012, excluding the funds injected into the country's banks, the government will have to find less than 10 billion euros to plug the gap in 2013.
It is also likely to be allowed to take two extra years, until 2016, to bring it below the European ceiling of 3 percent of gross domestic product.
The European Commission signalled that taking more time to reduce the budget shortfall would make sense for Madrid although no formal decision will be made until May 29 and EU finance ministers will have to sign off on it.
The International Monetary Fund also welcomed Spain's decision to ease up on its austerity drive, saying it should aid employment while still helping to return the nation to fiscal health.
Europeans officials had told Reuters earlier this week that the implementation of the reforms, not the size of the program, would be key to obtain EU blessing for the new strategy as a debate about Europe's austerity drive heats up, with Spain widely seen as a taste case for Europe's economic policy.
"What we've done in 2012 put us in a situation of not asking new big efforts to Spanish people," Spain's deputy Prime Minister Soraya Saenz de Santamaria said at joint press conference with Economy Minister Luis de Guindos and Treasury Minister Cristobal Montoro.
Saenz de Santamaria insisted the new forecasts were conservative and could benefit from a further fall in the country's borrowing costs as well as a gradual recovery of the euro zone economy.
Waves of liquidity from around the globe have largely offset the dire state of the Spanish economy, brought down debt costs and all but banished last year's fears that a budget crisis would force Madrid to seek a international sovereign bailout.
LEAN TOWARD GROWTH
Rajoy said Spain would always be disciplined on spending but he also recently indicated he would also now lean more to stimulating growth.
The new plans stick to this strategy.
While the government had to backtrack from its pledge to cut taxes as soon as next year, it said on Friday it was still aiming at cutting income tax in 2015.
It also said consumer taxes would remain unchanged but would review the energy and corporate taxes.
Other measures announced include a new reform of the public pension system, cutting the link between inflation and public sector wages, immediate steps to curb a growing energy tariff deficit and measures to boost small business growth.
The government also committed to review its 2012' flagship labour reform, for which it will likely seek the help of an international body such as the International Labour Organisation or the Organisation for Economic Co-operation and Development, a Spanish government official said.
The European Commission had said this was a condition Spain had to meet if it wanted to be given more leeway on the deficit goals and start creating jobs in a country where more than 6 million people are unemployed and social tensions are rising.
On Thursday around 1,000 anti-system protesters gathered at Spain's parliament calling for the government to step down and hurling objects, flares and firecrackers at heavily armed police who easily numbered more than demonstrators.
The protest was flagged as a "siege on congress" and several demonstrator groups stayed away because of feared violence amid heavy police presence.
Unemployment, which on Thursday rose to 27.2 percent would remain at a high level over the next two years at 27.1 percent in 2013, 26.7 percent in 2014 and 25.8 percent in 2015, the government said.
(Additional reporting by Paul Day and Andres Gonzalez)