Spain back in the crosshairs of crisis

Spanish Prime Minister Mariano Rajoy warned Wednesday that his country was facing “extreme difficulty” as its cost of borrowing money on global markets jumped and doubts increased about whether the government can stick to the strict austerity program designed to bring its debt under control.

Facing recession and treacherously high unemployment, Spain is struggling to keep its debt from exceeding targets set by European officials. So far, Spain has been able to remain in the good graces of international investors, raise the money it needs to finance itself and avoid the need for an international bailout.

But the country “is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty,” Rajoy said at a meeting of his People’s Party, according to wire service reports. “Anyone who doesn’t understand that is fooling themselves.”

In the past month, the borrowing costs faced by Spain — the fourth-largest economy in the euro zone — have increased sharply, renewing fear that the European financial crisis could dangerously escalate. An auction of Spanish five-year and 10-year bonds Wednesday was met with weak demand from investors; interest rates on the country’s 10-year note have risen above 5.6 percent, from less than 5 percent in early March.

Major European stock exchanges were off by more than 2 percent for the day, and the main Wall Street indexes were also lower.

Rajoy’s comments come as European Central Bank chief Mario Draghi warned the region’s political leaders Wednesday to adhere to promised budget and economic reforms in addressing the euro zone’s problems.

The central bank has taken several significant steps in recent months to keep the financial crisis from worsening but is increasingly torn between competing goals. The ECB’s chief mission is to battle inflation, which remains stubbornly above its 2 percent target. That could discourage the bank from taking new steps to stimulate the region’s economy. But many of the 17 nations that use the euro are in recession and looking to the bank for more help to boost their economies.

Speaking after the monthly meeting of the bank’s governing board, Draghi signaled that the onus is on governments to finish fighting the crisis.

The steps taken by the bank “are temporary in nature,” Draghi said. To truly restore stability, government debt targets and economic reforms “need to be fully honored,” Draghi said. “National policymakers need to fully meet their responsibilities to ensure fiscal sustainability.”

His comments come during what could be a critical interlude in Europe’s crisis. The threat of an imminent meltdown seems to have receded, and European officials agreed last week to boost the size of a regional crisis-fighting fund by about $250 billion — a step long urged by the U.S. government and others.

European banks are flush with more than a trillion dollars borrowed from the ECB at low interest rates, and Draghi said he expected that money to gradually find its way into loans to households and businesses to support the European economy.

But even that, he noted, is merely a temporary help — providing a “window” during which banks are expected to rebuild their financial health and governments are expected to trim debt and rejuvenate their economies.

Spain is now emerging as the critical test of whether that will happen.

Three nations — Greece, Ireland and Portugal — are receiving bailouts from other European countries and the International Monetary Fund. This emergency support frees the three governments from having to raise money on global markets, where the cost of borrowing could be prohibitive, and gives them several years to retool their economies and try to balance public budgets. Those programs have not always run smoothly, but in the case of Portugal and Ireland they have stayed largely on track. In Greece, the program was recently restructured to include a massive reduction in the value of government bonds held by private investors.

In Italy, reforms engineered by Prime Minister Mario Monti have so far earned the benefit of the doubt from investors and allowed the country to keep borrowing at affordable rates.

In Spain, however, Rajoy has said his government may miss the deficit targets being demanded by European officials. The country’s overall level of debt, while low in comparison with countries such as Greece and Italy, is at risk of rising sharply in coming years because of slow growth and high annual deficits.

The ECB, European leaders and the IMF have prescribed a rigid austerity program for Spain, including cuts in public-sector wages and higher prices for electricity and other public services. Spain faces a danger, however, that spending cuts could be so deep that they undermine the economy and leave government accounts in worse shape as tax receipts fall and social spending rises.

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