Spain is dealing with a complex economic and social situation. The Spanish economy is in recession, and it will contract by 1.5 percent in 2013, according to the Bank of Spain. Additionally, unemployment in Spain is currently at 26.3 percent, with youth unemployment at 55.7 percent. Rajoy's government is also dealing with growing social unrest related to the corruption scandals involving the ruling Popular Party and the rise of an anti-evictions movement that is increasingly harassing members of the Spanish Parliament. Moreover, in 2012 Madrid announced austerity measures for 2012-2014 amounting to 65 billion euros ($83 billion). A higher deficit target would allow Madrid to smooth the austerity measures this year in an attempt to reduce social unrest.

Brussels is also interested in reaching an agreement with Madrid. The Cypriot bailout increased the already strong political tensions within the European Union, and Brussels is afraid that the bloc fragmentation will deepen if it fails to be more accommodating with member countries. This dilemma is particularly strong for Germany, which is struggling to find a balance between pushing the eurozone periphery for austerity measures and conceding softer goals for countries in distress. The European Union fears that if it pushes Madrid too much, Spain could end up facing a political crisis similar to Greece's and Italy's. An anti-establishment party has yet to emerge in Spain, but there are already strong signs of popular discontent with the ruling elite.

Although granting Spain a softer deficit target could benefit the European Union in the short term, in the long run it would open the door for other members of the eurozone periphery (such as Greece, Portugal or Ireland) to ask for similar concessions — a frequent occurrence when an EU member receives special treatment. This would erode Germany's efforts to streamline the eurozone economies.

Madrid and the Regions

Madrid is hoping that a softer deficit target will help it improve its relationship with Spain's autonomous regions. In early 2012, Madrid pushed its 17 regions to meet strict deficit goals in an attempt to gain more control over the regions' spending and borrowing. The reaction was particularly strong in Catalonia, which used pressure from Madrid as a pretext to launch its independence project.

However, Catalonia needs money, and Madrid sees an opportunity to weaken the region's claims for independence. Under the current system, Catalonia has to cut spending by approximately 4.4 billion euros to meet the deficit target imposed by Madrid (0.7 percent of the region's gross domestic product). The Catalan government believes that, if the European Union grants Spain a softer deficit target, Madrid could pass that lenience on to the autonomous regions.

Catalonia hopes to be given a deficit target of 2 percent of its gross domestic product, which would put the needed spending cuts at a more tolerable level — 1.8 billion euros — for the Catalan government. Spending cuts are unpopular in Catalonia, and the regional government led by Artur Mas is hoping to have enough financial leeway to prevent a rise in social unrest. Moreover, Catalonia expects to receive around 9 billion euros in 2013 from the Autonomous Liquidity Fund, which Madrid created in 2012 to assist the autonomous regions and could be used as a negotiating tool by Rajoy's government.

A Possible Deal With Catalonia

In a sign that a deal between Madrid and Catalonia may be in the works, Rajoy and Mas held a low-profile meeting in Madrid on March 28. They discussed a softer deficit target for Catalonia, which both leaders saw as a first step in bringing Madrid's and Catalonia's positions closer. Catalonia is the wealthiest region in Spain (contributing roughly 20 percent of the country's gross domestic product), and despite their recent differences Madrid is interested in helping the region's economy recover.

Rajoy also has a political goal: to weaken the ruling coalition in Catalonia. Since late 2012, Catalonia has been governed by a coalition of Mas' Convergence and Union party and the Republican Left. This coalition has been fragile since the beginning, because the traditionally moderate Convergence and Union and the left-wing Republican Left have differing political views. Convergence and Union accepts that some austerity measures are needed to clean up the Catalan economy — an idea that is unacceptable to the Republican Left. In addition, the Republican Left more strongly supports Catalan independence, while some factions within Convergence and Union favor a rapprochement with Madrid. Rajoy is seeking to exploit these differences to generate a break in the Catalan government that would help weaken the separatist agenda.

The Spanish government is currently debating a new financing system for the autonomous regions. This new system would allow Catalonia to receive a greater share of the taxes collected in the region. Previous Spanish governments used this strategy to calm down independence claims in the country.

The strategy is not without risks for Rajoy and Mas. In Rajoy's case, the implementation of a new financing system for the regions could lead other Spanish regions to get more control of their taxes, which would diminish Madrid's fiscal resources and weaken its control over the autonomous regions. For Mas, an agreement with Madrid would mean breaking his main campaign promise. However, Rajoy and Mas' political and economic needs will probably make Madrid and Catalonia reduce tensions in the coming weeks, and dialogue between them — which had broken down until recently — is expected to intensify.