Is Spain too big to bail?

The vice gripping Spain tightened further overnight, as investors worried that the country was edging ever closer to a full-scale bailout.

So far, Madrid is continuing to deny – at least officially – that it needs an official bailout from the International Monetary Fund and the European Union. But Berlin and Paris are deeply aware that Spain's current predicament is untenable, and that an urgent solution needs to be found. Spanish bond yields are now well above the 7 per cent threshold, the point at which Ireland, Greece and Portugal sought bailouts.

Investors fear that the €100 billion rescue plan for the Spanish banks isn't enough to solve the country's deep financial troubles. They worry that with its interest costs soaring, the Spanish government has little chance of reaching its target of cutting its budget deficit to 6.3 per cent of GDP this year. And they're unimpressed by the country's latest €65 billion austerity cure, which they believe guarantees that Spain will be plunge into a bleak recession.

Spain, they fear, is now caught in the same vicious circle that has previously claimed Greece, Ireland and Portugal. As markets worry about the dire economic outlook, the higher interest rates climb. But this only grinds down the economy even further, because consumers and businesses – along with the government - are saddled with a higher interest bill. Some investors are now beginning to worry that with interest rates at such high levels, Spain will struggle to repay the €28 billion of its debt that matures in October this year.

In Madrid, there is intense frustration that the European Central Bank is not buying Spanish bonds in order to push the country's interest rate lower.

According to reports in the Spanish newspaper, El Economista, Spanish finance minister, Luis de Guindos, planned to urge his German counterpart, Wolfgang Schuble, to give the green light to the ECB to allow such purchases when the two met in Berlin overnight.

But there was little sign that any breakthrough had been reached. After the talks, the two released a statement saying that Spain's high borrowing costs failed to reflect "the fundamentals of the Spanish economy, its growth potential and the sustainability of its public debt”.

German members on the ECB board, including Bundesbank boss Jens Weidmann are vehemently opposed to the central bank buying up the bonds of debt-laden eurozone countries, and the ECB has not made any such purchases since March.

But investors worry that without ECB intervention, Spain's borrowing costs will remain prohibitive, and the country will have to resort to a bailout. According to the El Economista report, Madrid is mulling whether it should request a "bailout with flexible conditions”. This would include a temporary line of credit of up to €100 billion (which would cover the Spanish government's financial needs in 2012, including repaying the €28 billion in debts that mature in October and providing assistance to debt-strapped Spanish regional governments), and which would come on top of the €100 billion earmarked for the Spanish banks.

The report, which quoted unnamed government sources, said that Madrid is looking at alternatives to a classic bailout, which would be too expensive given the country is the fourth largest in the eurozone. "What's at stake is avoiding an imminent financial melt-down” the report emphasised.

Meanwhile, the former head of the Spanish central bank Miguel Angel Fernandez Ordonez, blasted the Spanish government for its handling of the country's banking crisis.

"In the first half of the year we have witnessed a collapse in confidence in Spain and its financial system to levels unimaginable seven months ago,” he told a committee of Spanish deputies. "Now we are not only worse than Italy, but worse than Ireland, a country that has been rescued.”

He added that "many things were done badly, and in particular, many things which should have been done to resolve the banking problem were not done”.