Spanish bailout looms as debt outlook darkens

Eurozone finance ministers to meet on October 8

After four years fighting the markets and a mushrooming economic crisis, Spain appears finally poised to cave in and apply for a sovereign bailout.

The economic descent has accelerated in the past few days: rising anti-austerity protests; snap elections over independence demands in Catalonia; and, this weekend, a darkening outlook for debt.

Hovering over the nation is the imminent threat of a sovereign debt downgrade by Moody's Investors Service, due by the end of the weekend, which could rate Spanish bonds at the equivalent of junk bonds.

The timing could be decided by the European Union's calendar; Spain is on the agenda for a meeting of eurozone finance ministers on October 8 and again for a European Union summit October 18-19.

Like Ireland, Greece and Portugal before it, Spain, whose economy is twice the size of all three bailed-out nations combined, can no longer afford to finance its debt on wary markets without help.

The next test comes Thursday when Spain will try to sell bonds expiring in two, three and five years on the same day that the European Central Bank holds its monthly meeting.

The ECB calmed debt markets in early September by outlining plans to buy the bonds of stricken eurozone states that apply for aid from eurozone bailout funds and submit to their strict conditions.

But as Spain hesitates to take the leap, interest rates have edged up again, with investors demanding a return of close to six percent to purchase its 10-year government bonds.

Investors don't anticipate that the ECB meeting this week will provide much guidance.

"In principle, we don't expect anything new because now it is the turn of the governments to take decisions," Spanish brokerage Renta 4 said in a weekly report.

Though openly fretting over the conditions of a bailout, Spain seems to be completing all its homework in preparation for such a rescue.

On Saturday it delivered to parliament a 2013 budget with 39 billion euros ($50 billion) in new spending cuts and taxes and plans for 43 new structural reforms negotiated with Brussels.

On Friday, the country took a key step by releasing an audit of its 14 major banking groups, half of which failed a severe stress test and will need some 59 billion euros in new capital.

Spain's government has already struck a deal for a rescue loan of up to 100 billion euros for the banks.

Madrid says it will probably need only about 40 billion euros from the eurozone loan because the lenders can find much of the cash elsewhere, including by selling assets.

 "The next hurdle is the bailout"

Eurozone and International Monetary Fund leaders welcomed the banking audit results.

On Monday, Prime Minister Mariano Rajoy will host the European Union's economic affairs chief, Olli Rehn.

The market reaction will demonstrate whether Madrid has managed to reassure investors.

"The next hurdle is the bailout which at this point appears to be inevitable," said Craig Erlam, analyst London-based foreign exchange broker Alpari.

"What matters to the market is that Spain asks for the rescue," said Montserrat Formoso Fraga, economist at Spanish fund manager Tressis.

Spain's budget and reforms were seen on financial markets as "a step closer to the bailout which, they believe, will solve the problems of

Spain and the eurozone," said a report by London-based foreign currency traders Moneycorp.

In the meantime, the figures seem to be getting to be worse.

The cost of pumping cash into Spain's troubled banks is expected to help send Spain's public debt to 85.3 percent of gross domestic product in 2012 and 90.5 percent in 2013.

It will also push the public deficit to 7.4 percent of output this year, Budget Minister Cristobal Montoro said Saturday, well above the 6.3-percent target that he had vowed to meet just 48 hours earlier.

Montoro argues, however, that the European Union target excludes the banking rescue costs, meaning Madrid can still realistically aim for a 6.3-percent deficit excluding that sizeable item.

Spain, like other rescued eurozone nations before it, is showing how difficult it is to trim a public deficit in the midst of a recession and with one in four workers unemployed.

The Bank of Spain this week said Spanish gross domestic product had declined at a "significant pace" in the third quarter of this year.
Public discontent is growing, with anti-austerity protesters packing into central Madrid on Saturday evening for the third night this week.

The strain is showing in particular in the Spanish regions, which are heavily indebted and yet responsible for half of all spending including on health and education.

The powerful northeastern region of Catalonia will hold snap elections on November 25 over an independence drive. Five regions have asked Madrid for help from a liquidity fund, with the requests already amounting to 16 billion euros.

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