Spain will have to play the right cards at the right time to shore up confidence and avoid sliding towards a full-scale sovereign bailout despite negotiating European financial assistance of up to 100 billion euros for its banks.
The country's struggle to meet its deficit goal for 2012, the risk that the banking sector clean-up moves too slowly and the need to tap the debt market for another 100 billion euros this year puts Spain just a few steps away from needing more external help, sources and analysts say.
Centre-right Prime Minister Mariano Rajoy has some room for manoeuvre even as he calls on the euro zone for immediate and medium-term measures to help restore credibility.
Despite its treasury minister declaring the bond market was closing to it, Spain has a strong liquidity position which will enable it to meet its debt obligations for at least another few months, and it has room to boost revenues by raising value-added tax or energy taxes.
But investors would have to believe in the programme in order for Spain to regain affordable access to debt markets after borrowing costs spiralled to euro era highs on fears the country's debt pile would soon reach unsustainable levels.
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Investors have also been spooked by the prospect of the banking bailout relegating private creditors to the bottom of the repayment pecking order should Spain ever default, since the euro zone's ESM rescue fund would be paid out first.
"The large share of effectively senior debt, a likely deterioration of macroeconomic conditions and fiscal overshoots do raise the spectre that the sovereign itself may yet need to request a bailout of its own at a later stage," Citigroup wrote in an analyst note.
Megan Greene, senior economist at Roubini Global Economics, which has been consistently bearish on southern Europe, sees a sovereign bailout as inevitable.
She argues that Spain's external debt position is unsustainable and off-balance sheet liabilities such as local corporations' debts will push public debt much higher than official forecasts of 79.8% of gross domestic product at the end of 2012.
"It could happen this year, but I would say it will happen by the end of the first quarter of next year," she said, referring to a rescue that could total as much as 700 billion euros and would stretch the currency bloc's rescue funds to breaking point.
A Reuters poll found 35 out of 59 analysts across Europe and the United States said it was "likely" or "very likely" Spain would need international help for its state funding within the next 12 months.
Spanish officials had anticipated the lukewarm market reaction to the bank bailout, saying it would do nothing to solve the country's risk premium without urgent European Central Bank measures and a roadmap toward euro zone fiscal union.
Rajoy, who is committed to austerity but concerned that higher taxes will prolong the economic contraction in Spain, renewed his call on Wednesday for joint euro zone action although there is no sign yet of the ECB being prepared to revive its bond-buying programme to give Madrid some respite.
Speed of the essence
Some analysts, and European Union officials in Brussels, see the banking bailout as a positive step, rather than the start of a negative chain reaction.
"Spain's sovereign debt will remain below 100% of gross domestic product and below the level of several other major economies in the euro zone, so we see no cause for concern," said one EU official, who asked to remain anonymous.
Interest payments on the rescue funds will likely accrue to Spain's public deficit, but that would be the case anyway if the country borrowed on the market to recapitalise its banks, and the market rate would be several percentage points higher.
With the country mired in its second recession in three years, one in four Spaniards unemployed and business bankruptcies rising, t h e government needs urgently to prop up lenders hit by a property crash and get credit flowing into the economy.
However, many details of the rescue remain unclear and will likely not be decided until an EU summit on June 28-29.
The final bill to clean up Spain's banking sector will also not be fully known until a comprehensive audit of the banks due July 31, while lenders will have until the end of the year to align their capital with the new requirements.
"To be quick is of paramount importance but I don't see it happening here," said a financial source working for one of the eight banks rescued by the state in the last two years.
"The restructuring plans have just been sent to the Bank of Spain, then we'll wait for the audit and then it's August so basically nothing is happening until September. The uncertainty will remain for some months," he said.
Meanwhile pressure mounts inexorably on Spanish debt - its 10-year yield hit seven percent for the first time on Thursday.
The 100 billion euros loans agreed on Saturday will push Spain's debt-to-GDP ratio higher than 90 percent, a level seen as dangerous even if lower than other euro zone countries.
At the same time, high bond yields will increase interest payments, weighing on annual spending and making it more difficult for Madrid to access funds on the market.
While the Spanish Treasury has about 44 billion euros in cash in its coffers thanks to better market conditions earlier in the year, the country still needs to tap around 100 billion euros to meet its funding needs for 2012.
About 52 billion euros will go to deficits at central government and regional level, and the rest will be used to repay debt maturing this year - 82 billion euros for the central administration and 15 billion euros in the regions.
A hump of 27.5 billion euros maturing in the last 10 days of October looks especially challenging.
Hiking taxes?
To add to the country's headaches, data from the first four months of 2012 show the deficit target will be hard to reach.
Revenues from consumer taxes dropped by 8.2% over the period, compared with the first four months of 2011, while unemployment benefits payments soared by 6.57%.
The central government deficit to April emerged at 1.43% versus an objective of 3.5% for the full year and the autonomous communities reported a deficit of 0.45% on the same period, compared to an annual goal of 1.5%.
Although income and spending vary over the year, this would put Spain on track to miss its targets by one percentage point.
Fitch, which slashed Spain's credit rating by three notches last week, said on Tuesday it saw the country missing both the 2012 and 2013 deficit targets.
"As of today and looking at the deficit data available, the possibility of complying with the public deficit target this year is rather small," said Cesar Cantalapiedra, partner at Analistas Financieros Internacionales research firm in Madrid.
Although the European Commission and Germany have said Spain could take an extra year, until 2014, to bring its deficit under the 3 percent-of-GDP limit allowed by EU rules Madrid is and will remain under close watch from its EU partners.
With a troika of international inspectors about to arrive in the country to monitor the banking sector restructuring, any slippage is likely to trigger increased scrutiny over Spain's fiscal policy from the European Commission, the European Central Bank and the International Monetary Fund.
That would put Rajoy under severe pressure to implement EU policy recommendations he has so far resisted.
In its annual assessment of the Spanish economy, released in May the European Commission recommended an increase in the value-added tax rate - one of the lowest in Europe - tax hikes on energy, an acceleration of last year's pension reform and deeper labour market reforms.