By Fiona Ortiz
MADRID (Reuters) - After a year of radical reforms that made Spain more competitive but also exacerbated a deep recession, Prime Minister Mariano Rajoy has largely lost his appetite for aggressive and unpopular cuts to pensions or state bureaucracy.
His plunging approval rating at home is holding him back as unemployment soars to 27 percent. Sources within the government say he has also reached the view that deeper reforms at home will win him few points in negotiations with European partners.
Rajoy, of the center-right People's Party, is under less pressure than last year after Brussels gave him more time to plug a budget gap. Borrowing costs have dropped to 2-1/2-year lows thanks to a European Central Bank pledge to backstop struggling euro zone countries and to cash from investors flush after an increase in global money supply.
He defended his policies before Parliament on Wednesday, saying he had chased off the specter of an international rescue for Spain and that he would continue making tough reforms to modernize the economy.
But he did not discuss details. Critics say the new reform package his cabinet agreed on two weeks ago puts off tough decisions on pensions and the cutting of public administration.
"No one made a greater effort than Spaniards in 2012," Rajoy told lawmakers, hinting that other countries in Europe need to match his effort on cutting costs.
Through tax hikes and spending cuts last year Rajoy cut more than 20 billion euros from the public deficit. An overhaul of Spain's labor market rules reduced the power of labor unions and cut the cost of hiring and firing.
Spain also cleaned up its wobbly financial system with 42 billion euros in aid money from Europe, although the cost of that rescue may still rise.
But this year his reforms are mostly a rehash of ideas that he had already put forward last year and which economists say they will do little to revitalize economic growth.
One urgent reform is to the pension system. Only 16 million Spaniards currently contribute to the pension fund, which supports 9 million people. And, as in many developed countries, Spain's population is aging.
Rajoy is negotiating a new formula for calculating pension payoffs, which he can sell at home as a gradual tweaking of the system and in Brussels as something that will be more impactful in the long-run.
Analysts say he is wary of going further for fear of sparking more intense street protests. Demonstrations against cost cuts have been frequent in Spain over the past two years, although they have mostly been peaceful.
The latest opinion polls show the PP has lost 10 percentage points of support since Rajoy's election in November 2011. Support for the main opposition group, the Socialists remains unchanged, while backing has been growing for smaller, more radical, parties.
More than 68 percent of Spaniards say the government is doing a bad or very bad job, while the latest official forecast shows that a quarter of the workforce will still be out of work three years from now.
FOCUS ON EUROPE
While his focus on new domestic reforms flags, Rajoy has turned towards Brussels to demand more action from the EU. He has repeatedly pressed Brussels and its paymasters in Berlin to move more quickly on Europe-wide reforms, saying that austerity in individual countries will be worthless without wider efforts.
He wants speedier implementation of a single euro zone banking supervisor and deposit guarantee fund, which would help Spain by spreading financial system risk across the bloc.
Rajoy has also called on the European Central Bank and the European Investment Bank to take action to help small businesses obtain funding: smaller Spanish companies must pay much higher interest rates on loans than, for example, German counterparts.
But slowing down reforms at home could cost him the leverage that he needs to make his case for stronger action in Europe.
Jose M. Areilza, a law professor at Spain's ESADE business school, said Rajoy has a limited window of opportunity to make changes at home and to push for change in Europe ahead of European parliamentary elections next year.
"Spain needs to push for things now. After the European parliamentary elections the mandate will not be for more Europe, it will be the other way around. There will be less European solidarity," Areilza said.
The PP has an absolute majority in Congress and some party members - most prominently outspoken free-market advocate Esperanza Aguirre, ex-president of the Madrid region - are pushing for Rajoy to move faster to cut public institutions.
While cutting flab out of the bureaucracy could be a popular measure - as opposed to fresh cuts to education and health spending - the potential rise in unemployment would not be.
In Parliament on Wednesday Rajoy said he has eliminated 370,000 public jobs. Spain's spending on public administration is already lower than the European Union average.
However, those seeking more cuts argue that there is still room to scale back. Many of Spain's autonomous regions have offices that duplicate efforts by the central government. For example there are multiple anti-monopoly watchdogs.
Within his cabinet, Rajoy's economic advisers are divided on the issue, and the notoriously cautious prime minister says he is waiting for the results of a study, due in June.
"On the one side you have people saying we should take advantage of the crisis to reform, no matter what the political cost. But the more political members of the government say it doesn't make sense to carry out unpopular reforms if you aren't going to be in power," said Jose Ignacio Torreblanca, head of the Madrid office of the European Council on Foreign Relations think tank.
(Reporting by Fiona Ortiz; Editing by Peter Graff)