Marooned on Spain's austere coastline

Financial markets face a torrid start to the week, with fears mounting that Spain – the eurozone's fourth largest economy – will soon be forced to seek an official bailout.

Last Friday, Spain's stock market slumped by almost 6 per cent, dragged down by bank shares, as investors found little to celebrate in the eurozone's latest €100 billion ($US121 billion) bailout of the Spanish banks.

Sentiment soured sharply after Madrid slashed its growth forecasts – it now expects the Spanish economy will shrivel by 0.5 per cent next year rather than post the weak 0.2 per cent growth it was previously hoping for – and the Spanish region of Valencia said it would tap the new fund that Madrid has set up to help regions facing financial difficulties.

Ominously, the deepening despair pushed Spanish borrowing costs up sharply, with 10-year bond yields hitting 7.28 per cent – a level considered unsustainable. Investors now fear that Spain has little option but to follow the same humiliating path as Greece, Ireland and Portugal and request a full bailout from the European Union and the International Monetary Fund. They calculate that the Spanish government will need a bailout of around €300 billion, on top of the €100 billion already approved for the Spanish bank bailout.

Investors worry that Spain is heading down the same path of economic doom that Greece has mapped out, even though Spain has a functional government that is capable of raising taxes and pushing through tough reforms. They know that the latest €65 billion austerity cure announced by Spain's prime minister, Mariano Rajoy, is bound to plunge the economy even deeper into recession and to trigger growing social tensions in a country where one in two young people is unemployed, and where company failures have soared by 400 per cent since 2007.

Indeed, Madrid is now witnessing demonstrations on an almost daily basis. Last Thursday, hundreds of thousands of demonstrators hit the streets to protest against Rajoy's latest budget cuts. On Saturday, thousands of jobless Spaniards from around the country converged on Spain's Puerta del Sol, calling out, "Hands up, this is a robbery”.

Spain is now paying a hefty price for its decade-long economic madness. Its fantastic property bubble has now burst, leaving behind a crippled economy and a disfigured coastline, and cleaning up the mess will take years. Spanish banks – which are sitting on €184 billion in bad debts – will need to be cleaned up. Debt-laden households, squeezed because the interest bill on their borrowings often exceeds their disposable income, will have to find a way to deleverage. The economy will have to be weaned off its dependence on property and construction – the source of the country's artificial economic vitality for the past decade – and Spain will have to rebuild a diversified industrial base.

Madrid, like Athens previously, is now under pressure to reduce its budget deficit by raising taxes and cutting spending. And, like Athens, it is doing it badly. Madrid is saving money by cutting spending on education, even though the country's school system is already considered sub-standard. It's also freezing spending on infrastructure, and cutting back the funds flowing into research and development.

Critics argue that such budget cut backs are disastrous. Not only do they condemn Spain to a bleak economic future, but they have failed to reassure financial markets, which have continued to push Spain's borrowing costs to near record levels.

And they warn that the entire euro project will be doomed if Europe follows the same recipe with Spain as it did with Greece, and stipulates that Madrid will only receive a full bailout if it agrees to impose further harsh budget cuts on its already crippled economy.