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Spain acts tough on debt, but investors say 'situation could still get ugly'

Spain has slashed government spending amid a stagnant economy and 20 percent unemployment. But investors aren't yet fully convinced that Europe's fifth largest economy is out of the woods.

By Correspondent / December 10, 2010

Spanish Deputy Prime Minister and Interior Minister Alfredo Perez Rubalcaba (l.) and Economy Minister Elena Salgado attend a joint news conference at Moncloa Palace in Madrid on Dec. 3.

Andrea Comas/Reuters

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Madrid

Spain's effort to convince financial markets it will weather its worst economic crisis in decades without needing a bailout is falling on deaf ears.

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Finance Minister Elena Salgado reiterated Friday that “there’s nothing in our economic situation indicating that we would need to ask for financial assistance from abroad.” Yet as she said this, yields on Spanish government debt rose to near record highs, increasing Spain's borrowing costs.

The consensus view among economists in Spain is that a government default is highly unlikely. But the chance of it – however slight – is a major concern for Europe. Has the Spanish bull of yore shed its horns or will it bounce back as the government insists? The country is Europe's fifth-largest economy and a pillar of the 16-member euro zone's stability. If Spain has to be rescued like Greece and Ireland, the euro currency could be at stake.

The Socialist government of Prime Minister José Luis Rodríguez Zapatero, like other European governments, has pushed through extremely unpopular austerity measures, despite stagnant growth and a whopping 20 percent unemployment rate (the highest rate in the European Union), to show markets it’s serious about getting its budget deficit under control.

Last week the government approved a tobacco tax increase and a partial privatization of its national lottery and airport authority. It also cut unemployment benefits and taxes for small- and medium-sized business, and promised to speed up pension reform. That comes on top of a $19 billion package approved last May that included severe public-spending cuts. The government’s resoluteness, at the expense of its popularity, has earned the praise of EU officials, especially with the deficit falling from 11 percent of the gross domestic product to around 9 percent, which is still far from the 3 percent goal set for 2012.

Not buying it?

Markets though remain unconvinced. The yield on Spanish 10-year bonds edged to almost 5.4 percent, compared to the nearly 3 percent demanded for German debt, the euro zone's benchmark. That 240 basis point spread between them reflects the risk premium investors are demanding to hold what they see as riskier Spanish debt. The spread has narrowed recently from a record of 270 basis points.

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