It noted a backdrop of political instability after two inconclusive elections inside a year and eight years trying to haul itself back into shape following the 2008 economic crisis.
Two months ago, Madrid just avoided an EU fine for repeated breaches of budget rules.
Brussels let both Spain and neighbouring Portugal off the hook, judging that both were trying to get their house in order and close in on the official ceiling of 3.0 percent of GDP.
But the EU told both countries to stay on a path of "fiscal consolidation" as the only way to create a foundation for durable growth.
Brussels did not immediately comment on the latest forecast for the eurozone's fourth largest economy.
After six years in recession, Spain reported a 2015 budget deficit of 5.1 percent of GDP, way off the 4.2 percent target set by the Commission.
For this year, Madrid must pare the deficit to 4.6 percent, and then 3.1 percent in 2017 - which it will now miss - then 2.2 percent in 2018.
Vote of confidence
Conservative Prime Minister Mariano Rajoy is clinging on to power after his Popular Party retained its status as the largest party. His failure to win a majority has left Spain effectively rudderless, hampering attempts to finesse spending plans which could underpin a cautious economic upsurge.
The budget report, seen by AFP, recognises that government plans to bolster revenue, including tax hikes for companies which it hopes can net €8 billion ($9 billion), will not suffice.
Growth is also fraying at the edges with the government now forecasting 2.9 percent for this year - down from a central bank forecast of 3.2 percent. For now, Spain is sticking with the bank's 2017 prediction of 2.3 percent.
The economic crisis wrought havoc with the job market, Spain's traditional weakspot, with unemployment peaking at 27 percent before falling back.
Madrid now sees the jobles rate falling from 19.7 percent to 17.8 percent next year, still well above the eurozone average of 10.1 percent.
All eyes are now on whether the political weather will clear as a divided opposition Socialist Party debates whether to abstain in a parliamentary vote of confidence to allow Rajoy to form a new government, the alternative being a third election in a year come December.
The Socialists are to debate their strategy on October 23rd before the expiry of an October 31st deadline to form a new government or hold fresh polls.
By Adrien Vicente / AFP