Spain too big to fail, too big to be rescued

(MADRID) - The European Union has bailed out Greece, now Ireland and should have no trouble helping Portugal if needed, but analysts warn that financially ailing Spain could prove too costly to save.

After riding to the rescue of Greece in May with a 110-billion-euro (147-billion-dollar) package, the EU and International Monetary Fund announced a 750-billion-euro safety net for troubled eurozone countries to try to calm jittery markets.

The move worked, but now that Ireland has asked for a bailout estimated to be worth around 85 billion euros and markets are putting pressure not only on Portugal but Spain as well, analysts have begun to ask whether the EU could really bail out one its major economies.

Spain is not one of the eurozone's peripheral countries, but the fourth largest. It accounts for 12 percent of economic output among the 16 nations that use the euro currency, equal to twice that of Ireland, Portugal and Greece combined.

"Back in May and June the market wasn't so worried about the outlook for Spain," said Kathleen Brooks, a research director at Forex.com in London.

"But post the Irish debt crisis, Spain has come centre stage as investors fear that if its debt problems become too much for it to handle then it could be too big for the EU-IMF to bail."

Investors have been demanding higher and higher rates in return for taking the risk of buying Spanish debt.

On Wednesday, the rate which Spain has to pay to borrow for 10 years rose above 5.0 percent for the first time since 2002 and to a record gap above the German borrowing rate, a critical indicator of alarm.

Similar rising bond yields occurred when Greece and Ireland fell on the slippery slope towards bailouts.

The higher interest rates make it more difficult and costly for Spain's government to borrow money, meaning that it will be forced to cut spending and raise taxes even further.

As the Greek crisis unfolded earlier this year, Spain's government adopted tough austerity measures: cutting spending, hiking taxes and restructuring the weak regional savings bank system.

While it has made progress with the austerity programme, the country's weak point could be a lack of growth coupled with the European Union's highest unemployment rate at almost 20 percent.

At Capital Economics, senior European economist Jennifer McKeown said that although the risk of a Spanish bailout was "fairly low ... the cost would be devastatingly high."

McKeown estimated that a rescue for Spain might soak up 420 billion euros. "Europe might be unable to stretch this far," she said.

MRL Corporation chief executive Cornelia Meyer put it as high as 500 billion euros, in an interview with CNBC television this week.

Because a part of the European bailout money is to be held back to guarantee funds issued, the real amount available to governments is on the order of 660 billion euros, according to McKeown.

With Ireland expected to gobble 85 billion of this and assuming Portugal would request a similar amount if forced to seek a bailout, the balance drops to 490 billion euros, raising doubts whether there would be sufficient funds to rescue Spain.

"The real worry continues to be Spain which, if it were to require EU cash, would almost certainly use up most if not all of the funds and probably need further money down the line," said CurrenciesDirect analyst Alistair Cotton.

McKeown said that "the small risk" that Spain might need help "is perhaps the most serious threat to the eurozone's future" and "closely linked to the risk of some form of eurozone break-up."

The ultimate question is how Germany, which has always demanded tougher fiscal rules to ensure the euro is stable and is pushing for a tougher system, would react to the need to bailout a major eurozone economy.

Capital Economics in London, for example, issued a note saying, that if Germany did not obtain the changes it wanted in the EU and eurozone "it may decide to cut its losses and leave monetary union."

Or it might get its way but some weaker countries might not like the effects and "then choose to leave."