Spanish crisis

It seemed like a good sign at first. The European Commission praised Spain for its reforms and budget cuts. EU Monetary Affairs Commissioner Olli Rehn on Wednesday even promised the country it would get one extra year to make savings than previously planned, on condition that "Spain reduce the excessive expenses of its regions and presents a solid budget for the next two years." That would mean that Spain would have until 2014 to get its deficit below the 3 percent mark.

But doubts are multiplying in the EU that Spain is capable of lifting itself out of its debt swamp. The country has a huge problem with its banks, which are holding billions of euros worth of bad loans. The fourth biggest Spanish bank, partially state-owned Bankia, for instance, reportedly needs 23 billion euros ($28.5 billion), and it remains unclear where the money might come from.

Eurozone in peril

This situation gives the EU Commission's leniency a bitter aftertaste. Delaying Spain's deadline actually highlights the seriousness of the situation and the helplessness of all parties. Problems for a European heavyweight like Spain could shake the foundations of the whole eurozone.

Most experts fear that if Spain needs to be bailed out by the European rescue fund, then the fund could be torn apart by subsequent financial burdens. That has led many EU officials to consider accepting any supporting measure.

"It's the eleventh hour for Spain," said Daniel Gros, director of Brussels think tank the Center for European Policy Studies (CEPS). "The Spanish banking system will soon be unable to refinance itself, and the Spanish government will have to pay interest that it can't afford in the long-term."

But he added that it would be a mistake to use the rescue fund to finance the entire Spanish economy. "Europe can't afford that, because Spain is simply too big," Gros said. Instead, the EU needs to find a way to recapitalize the Spanish banks without breaking the state's back.

"What the Spanish banks need is not more loans, but capital," Gros said. "And the Spanish state cannot provide this capital, because it simply doesn't have the money."

Swallowing national pride

That means the financing needs to come from a European source. "First and foremost from the EFSF, the European bailout fund," Gros said. But, he explained, since the fund was designed to support ailing states, not to save struggling banks, it would have to be modified.

"Then the bailout fund could recapitalize Spanish banks, and of course take control of them," he said. This is an idea that is also being discussed by the EU Commission - though it might well prick Spanish pride.

In the meantime, the Fitch ratings agency has once again given Spain the thumbs down. It has downgraded eight of Spain's regions, or autonomous communities, including Madrid. For Gros, it was an unsurprising decision, since the Spanish autonomous communities, some of whom crave independence and boast almost the same powers as German states, have "repeatedly undermined the central government's attempts to make cuts," he said. "That's why they need to be called to account more sternly, so that they only spend as much as they take in."

Gros said the Spanish government could achieve this by no longer allocating them money.

"If the government stayed tough, it could tell the relatively rich state of Catalonia, for instance: 'We're not going to rescue you anymore - you have to do that yourselves.' Then they'd soon learn some budget discipline."

Selling out the welfare state?

In the meantime, pressure is mounting on the Spanish government. The financial markets are unlikely to stand by as Spain runs up a deficit of 8 percent or 9 percent of the gross domestic product. There is no alternative to making budget cuts, but it will be hard to get a fractious Spanish population to accept them - as occasionally violent demonstrations in March showed.

On top of that, the country's trade unions are stirring up the situation by accusing conservative Prime Minister Mariano Rajoy of "selling out the welfare state" under the guise of making necessary budget cuts.

The EU and the Spanish government are now desperately trying to calm the situation. German Chancellor Angela Merkel is appealing for faith in the Spanish reforms and the stabilization of the European banks. After a meeting of the Council of the Baltic Sea States (CBSS) on Thursday, she spoke of Spain as an ally "on the path to fiscal consolidation and simultaneous growth."

But it's doubtful whether this will go down well with the Spanish population - withdrawals from Spanish banks have increased ominously in the past months.

Author: Ralf Bosen / bk
Editor: Sean Sinico