(Corrects to show deficit limit is for structural shortfall) * Spain govt, PP agree on reform to cap deficit, debt * Law will cap structural deficit at 0.40 pct of GDP from 2020 * New law will allow for some flexibility in times of crisis
(Updates with details, comment)
By Judy Macinnes
MADRID, Aug 26 (Reuters) - The Spanish government said on Friday it had reached an agreement with the main opposition People's Party (PP) to establish limits on the public deficit and debt as part of the constitution.
The constitutional amendment, which will not include specific deficit cap figures, will be accompanied by a law which will set a ceiling for Spain's structural deficit over the course of an economic cycle at 0.4 percent of gross domestic product (GDP).
The law must be approved before June 30, 2012, and will come into effect from 2020, the government said in a statement early on Friday morning.
The move follows calls by Germany and France for countries immersed in the euro zone's debt crisis to set obligatory limits on deficits to regain the trust of investors.
Spain's deficit is at the heart of concerns it could need a bail-out like Greece. It has pledged to bring its headline public sector shortfall down to 3 percent of GDP by end-2013, in line with European Union guidelines.
Spain has slashed the headline deficit, one of the highest in the euro zone, to an expected level of around 6 percent of GDP at the end of this year from 11.1 percent in 2009.
The constitutional amendment, only the second since it was drawn up after the end of Francisco Franco's dictatorship in 1978, will not include a deficit figure to give the economy greater flexibility during times of crisis.
The framework for the law says the central government's structural deficit should not exceed 0.26 percent of GDP, while that of each regional government should not be over 0.14 percent. Local governments must present a balanced budget.
The law will also establish criteria for the progressive reduction in the level of the country's debt in line with the euro zone's growth and stability pact, the government said.
Both parties subscribing to the agreement can revise the deficit caps in 2015 and 2018.
Spain's Prime Minister Jose Luis Rodriguez Zapatero, who will not be renewing his term as leader of the Socialists in November's general election, said he wanted to set the constitutional cap before he left office.
Following Zapatero's announcement, economists applauded the call to include some level of budgetary prudence in the constitution saying it would help assure markets concerned by the fiscal outlook.
"This proposal comes as a (positive) surprise as it was expected that an expenditure-ceiling rule would be voted by each of the regional parliaments in September, but there is no guarantee that every regional parliament would support it," Barclays Capital said.
"However, the proposed constitutional amendment would automatically apply to all levels of the government, including the regions."
(Additional reporting by Paul Day; Editing by Alison Williams)