European stock markets plunge amid growing concern about Spain's ability to avoid bailout despite severe austerity measures
The eurozone entered crisis mode again on Tuesday as financial markets placed Spain firmly in their sights and investors began a concerted sell-off of Spanish debt amid growing scepticism over the country's ability to escape a bailout.
Italy's debt also came under pressure, and stock markets plunged around Europe, signalling the end of a period of respite bought with €1tn (£824bn) of cheap loans to banks from the European Central Bank in recent months.
Spanish bond yields soared to a four-month high, stocks fell to a three-year low, and the central bank governor, Miguel Ángel Fernández Ordóñez, warned that banks would need more capital if the recession-hit economy were to get worse.
Austerity measures approved by prime minister Mariano Rajoy's conservative government appear set to drive an economy with 24% unemployment into even deeper recession. The cuts and tax rises of about €27bn announced last week have failed to calm fears that the eurozone's fourth biggest economy will need a partial bailout.
Spain's economy is more than twice the size of those of Greece, Ireland and Portugal combined, and the fallout from any deepening of the Spanish crisis is expected to have far-reaching consequences for Europe as a whole. Worries are now concentrated on Spain's banking system, which has done little to shed the toxic real estate it had on its hands when a housing bubble burst four years ago.
A nervous government announced at the weekend that it would pass laws to provide a further €10bn of cuts to health and education services.
It left the job of making those cuts, however, to regional governments. Sources at Rajoy's official residence, the Moncloa palace, told the Guardian that the €10bn figure was for a full year, rather than for the eight months left in 2012.
The government, meanwhile, stepped in to correct the finance minister, Luis de Guindos, after he suggested that it was time to start charging people, especially the rich, to use public health services. "We need to open the debate in the central government and among the regions on whether the health service should be free for someone earning €100,000," said De Guindos.
Last year, Spain missed its deficit target of 6%, with regional governments failing to cut their spending and markets losing belief in the country's ability to control them.
Eurozone finance ministers have insisted that the resulting 8.5% deficit has to be cut to 5.3% this year, and 3% in 2013 – a huge task that Spanish economists have described as simply impossible.
"It is a form of mutual suicide," said one. The economy is already slated to shrink by 1.7% this year, and analysts believe the total adjustment of more than €60bn over two years, or almost €1,500 per Spaniard, will deepen that further.
With almost one in four out of work, Spaniards have begun to turn on Rajoy's government, which nevertheless insists on sticking to its austerity programme.
"Are we going to meet the deficit target? The answer is 'yes' and 'yes'," said a Moncloa palace source.
Officials are waiting for Bank of Spain reports on the state of the various individual banks as they adapt to a recent reform requiring them to come up with an estimated €50bn in provisions to cover real estate holdings.
Analysts worry the reform is too little, too late. Many loans to developers have been rolled over while banks have also had to accept properties and land in lieu of payment. With house prices tumbling and building land often worthless, several small banks have had to be rescued with taxpayer money.
Some analysts see Spain eventually requesting a partial bailout by taking money from the European financial stability facility to prop up the country's banks.
Fernández Ordóñez said that more capital would definitely be needed if Spain's economy were to collapse further. "If the economy worsens more than expected, it will be necessary to continue increasing and improving capital," he said.
He admitted that eurozone membership, which means that Spain cannot resort to devaluing its currency, makes the task of adjustment harder. "The solutions to the crisis, which came from excessive debt or loss of competitiveness, are very slow within a monetary union," he said.
Government officials insisted they would press ahead with their existing reform programme, but also expressed frustration that European partners were not doing more to help solve a wider eurozone problem and ease the pressure.
Rajoy's government promises fresh reforms in the coming weeks. Privatisations will help reduce the number of public companies owned by central government from 300 to 215.
It also wants regional and municipal governments to prune the 4,000 or more public companies they own, and to privatise the management of regional broadcasters.
A key law will see central government given powers to intervene in regional governments which fail to meet deficit reduction programmes.
Health and education reforms, which will almost certainly shrink services and may see university fees raised, will also come in the next few months. Government sources ruled out any desire on the government's part to leave the euro.
David Song, a currency analyst at DailyFX, said the renewed pressure on eurozone debt meant the euro would continue losing value against the dollar. "The single currency is likely to face additional headwinds over the near-term as the region continues to face a risk for a prolonged recession," he said.
Analysts at Spain's BBVA bank said that long-term growth prospects for the country looked good, however, as exports grow, the balance of payments deficit shrinks, and productivity growth outstrips changes in labour costs.