Weekly Report (06.05.12)

Unemployment 24.44%

Following the new ‘labour reform’ of the Rajoy Government taking effect, 5,639,500 people are now without work in Spain, 24.44% of the working population, amounting to an increase of 365,900 in the first quarter, the highest in recent history and the highest in the European Union.

1.7 million Spanish families are without even one person working, 153,400 more than the last quarter.  In Andalusia, one in every three of working age is without a job.  In The Canaries unemployment is 32.28% and 36.95% for foreign workers.

Fernando Jimenez Latorre, Secretary of State for the Economy, has assured us that

unemployment will not exceed 25 % this year …….

 

Rating close to garbage

Standard & Poor’s has downgraded Spain’s credit ratings from A to BBB+, only two points above that considered ‘garbage’. This is the answer to the erratic financial policy of the Rajoy Government, delaying presenting a budget for this year; giving firm promises on what will not be cut, only to make drastic cuts the next day; not being able to make the Regions (almost all PP controlled) toe the saving line; not preventing the economy sinking deeper into recession and not solving the banking crisis.

 

Chaos in health administration

In last week’s Weekly Report we described the exploitation of the Spanish health services by some groups of foreigners, ‘only possible because the laws and rules were vague and imprecise.’  This week we have been proved right by The Court of Accounts in a demolishing report describing the chaos and mistakes in the  application of the rules in relation to the treatment of foreigners in the health services.

The report points to lack of updating of tariffs, issuing of health cards to foreigners not qualifying, duplication of health cards, lack of digitalisation of data and failure to send the bills for services to the countries of the foreigners. The regions have failed to bill 45% of the costs of pharmaceuticals, loosing 4.5 million euros per year.

Neither have they billed emergency attention, loosing an additional 3.55 million.

The Court points to a number of Moroccan citizens taking their Spanish health card with them when returning home, continuing to charge Spain for health services obtained in Ceuta and Melilla.

 

Saving the Spanish banks?

The European Central Bank and the leaders of the Euro Zone are busy discussing the possibilities of how to save shaky Spanish banks, filled with rotten property sector debts.  The exposure of the banking sector to ‘bricks’ is 450,000 million euros; it has been proposed that the resources of the rescue fund should be used for that.  ‘Wise’ European leaders hope that by saving the banks – largely responsible for the property bubble – they may avoid having to rescue the country.  A futile hope.

Higher fiscal pressure

OECD, the Organisation for Cooperation and Economic Development, have monitored the fiscal pressure in various countries.  One finding was that in 2000, 38.6% of the gross salary of the average Spanish single employee is paid back in taxes and social security, compared with an average of 36.6% for all OECD countries. From 2000 to 2011 this part, representing the tax pressure, rose to 39.9% in Spain, compared to an average of 35.3 for all countries.

In 2011, the average wage Spain was 34.953 euros, compared with 49,823 in Germany, 44,575 in France, 38,816 in USA and 36,372 in Italy.

Regions intervened?

A new law permitting the Government to intervene in the Regions which do not toe the line on reducing their deficits, has sent regional governments into a frenzy of cost cutting. The government of the Balearic islands have decided to close down two hospitals, the Hospital General and Juan March; increase the working hours for functionaries from 35 to 37.5 hours a week; save 35 million euros in education and 23.4 on the environment.

Even more taxes…..

The Government when it took office a few months ago promised there would be no increases in taxes on consumption. Now it has been announced that as from next year, a higher level of VAT will be introduced, as well as increases on the ‘Special Taxes’  for tobacco, alcohol and petrol.

Accelerating crisis:

After downgrading the debts of the Kingdom of Spain to BBB+  just two steps over ‘rubbish’, the rating agency Standard & Poor’s has reduced the ratings of 11 Spanish banks: Banco Santander and its two filial, Banesto and Santander Consumer Finance; BBVA; Sabadell; Ibercaja, Kutxabank; Banca Civica; Bankinter; Barclays and the confederation of saving banks, CECA. Sabadell and Banca Civica, are now classified as ‘rubbish bonds’

In its latest issue ‘The Economist’  said Spanish banks needs between 60,000 and 80,000 million euros to survive

Foreign investment in Spanish public debts fell 21.9% in the first quarter compared with the last quarter of 2011

The National Office of Statistics have confirmed a recession of 0.3% in the first quarter

The stock exchange lost 12.5% of its value during April month.

 

Prophecies and good sense

In our Yearly Report 2011-2012, written in December, we made certain predictions about what would happen this year. Among them were the following two:

‘As a result of the cuts and the recession, unemployment will go above 25%’ and
’Spain will have increasing difficulties in finding new money to repay soaring public debt and subsequently the ‘country risk’ will rise and Rajoy may be forced to ask for a rescue package’

Last week the Government had to admit that unemployment at the end of April had increased by 365,900 people, reaching 24.44% of the working population. That means within 3 months we are only 0.66% away from a situation where 1 in 4 Spaniards have joined the jobless and 52% aged under 25 years are without work. With the severe cuts in regional and local administration announced by the Government, all analysts agree that unemployment will increase in the coming months.

The Country Risk

At the end of 2011 the Country Risk stood at 385 points (measured as the difference on what Germany had to pay in interest on 10 year public bonds). Over the past weeks the risk level has been permanently above 400. The interest rate on Spanish bonds is swinging around 6%, the point where an international intervention is being prepared, ready to be employed when the interest rate hits 6.5%.

We have previously said Spain is already being rescued, by the European Central Bank massively buying Spanish bonds in a vain hope to encourage financial investors to do the same. With the downgrading last week of Spain’s solvency from A to BBB+ by rating agency Standard & Poor’s (just two levels over rubbish) investors will certainly think twice before buying Spanish bonds.

The European Central Bank has given enormous sums to the European banks with the express hope they will be using the funds to buy government bonds.
Predictions fulfilled

We consider that our predictions from December have already been fulfilled and wait with trepidation what the rest of the year will bring.

Prophecies are difficult. But you can see better with good sense.

Following is the text of the mission assessment from the International Monetary Fund’s visit to Spain:

A Financial Sector Assessment Program[1] (FSAP) team led by the Monetary and Capital Markets Department of the IMF has visited Spain between February 1-21 and April 12-25, 2012, in order to conduct an update of the Fund’s 2006 assessment of the soundness and stability of Spain’s financial sector. Such assessments are undertaken about every five years. The following provides some initial findings from the mission. These findings are subject to further review, and will also serve as background to the Article IV discussions to be held with the IMF’s European Department in late spring 2012.

The Spanish authorities are focusing on strengthening the financial system, a crucial condition to support the broader process of economic recovery. A major and welcome restructuring of the savings bank sector is taking place, but the capacity to cope with the needed adjustments differs significantly across the system. The largest banks appear sufficiently capitalized and have strong profitability to withstand a further deterioration of economic conditions, but vulnerabilities remain in other banks that are reliant on state support, and the sector as a whole remains vulnerable to sustained disruptions in funding markets.

The assessment confirms the need to continue with and further deepen the financial sector reform strategy to address remaining vulnerabilities and build strong capital buffers in the sector. A carefully designed strategy to clean up the weak institutions quickly and adequately is essential to avoid any adverse impact on the sound banks. Furthermore, dealing effectively and comprehensively with banks’ legacy problem assets should be the priority of the next stage of the financial reform strategy.

1. The past four years have witnessed a crisis of unprecedented proportion in the Spanish financial sector in its history. While external factors contributed to the turmoil, significant risks posed by a real estate boom-bust cycle, which materialized in the savings bank sector, exposed weaknesses in the policy and regulatory framework and an over reliance on wholesale funding.

2. A major and much needed restructuring of the savings bank sector is now taking place in the aftermath of the real estate boom-bust cycle. Reforms to the savings banks’ legal framework together with financial support from the state-owned recapitalization vehicle (FROB) were instrumental in starting the much-needed reform process to restructure the banking sector. The number of institutions has been reduced from 45 to 11 through actions including interventions, mergers and takeovers. These actions have been focused on the weakest institutions, and by the end of 2012, institutions representing about 15 percent of the system with total assets equivalent to over 50 percent of GDP will have been resolved.

3. Recently, loan loss provision requirements have been increased for the banks in anticipation of expected further credit losses related to the real estate sector and the weak macro-economic environment. It will be difficult for some banks to meet this new requirement, however, and the markets’ perception of rising sovereign and banking sector risk may put further strains on banks, especially those that face large wholesale funding needs.

4. The team’s stress tests, which covered more than 90 percent of the domestic banking sector, showed that most banks would be resilient to large further shocks, although there were pockets of vulnerabilities. Lender forbearance--which the supervisory authorities have indicated they are monitoring closely--could not be fully incorporated into the stress tests due to lack of data--and this may have masked the extent of credit risk in some institutions. The team’s results suggest:

· The largest banks appear sufficiently capitalized and have strong profitability to withstand the expected further deterioration of economic conditions. The solid capital buffers of most banks as well as the robust earning capacity of the internationally diversified large banks have reduced system-wide solvency concerns to a relatively low- probability event of a confluence of adverse macroeconomic developments.

· A group of ten banks, most of which have received state support and are in varying degrees of resolution strategy, were identified as being vulnerable. Five of them have been acquired by or merged with other solvent entities. Three are in the process of being auctioned and the remaining two have submitted business plans that have been approved by the central bank. To preserve financial stability, it is critical that these banks, especially the largest one, take swift and decisive measures to strengthen their balance sheets and improve management and governance practices.

Mr Rajoy, the figures don't add up

Economists argue that Spain's draft budget underestimates pension costs and overestimates extra revenue from tax hikes

Spain has set its course and there is turning back" has been Prime Minister Mariano Rajoy's mantra since taking office in January after committing himself to reducing the budget deficit from 8.5 percent of GDP to three percent by 2013 in a bid to avoid an ECB and IMF bailout, as has happened in Greece, Portugal, and Ireland.

The prime minister said on April 13 that it was "not possible" for the EU to rescue Spain: "If we don't meet the deficit targets, they will stop lending to us, and if no one lends to us, they will have to rescue us. Because the government rules out the possibility of a rescue and intervention, that's why we're implementing reforms."

Determined to fulfill the constitutional amendment agreed last year with his predecessor José Luis Rodríguez Zapatero that obliges the government to balance its books well ahead of its 2020 deadline, the prime minister's goal for this year is reduce the deficit to 5.3 percent.

He says he can do so without reducing pensions and unemployment benefits or cutting civil service salaries, which collectively make up 40 percent of government spending.

Few, including the Bank of Spain, believe that Rajoy can pull it off without going back on his word.

"It is extremely unlikely that the current budget will enable him to reduce the deficit by 3.2 percentage points of GDP: spending has been cut by just 1.1 percent on last year," says José Ignacio Conde-Ruiz of the economic research group FEDEA. "To reach his goal we will have to make the biggest cuts in modern history, and that can only be done by taking the knife to major items like salaries, pensions, and other welfare benefits. Then there is the question of whether doing so would be a good idea at a time of deep recession."

"Reducing the deficit needs to be done more gradually: austerity in itself is not enough," says Antoni Castells, an economist who advised the previous Catalan regional government. "Spain is being forced by Brussels to push ahead, and anything it says to the contrary will only undermine its credibility further," he adds.

Santiago Lago, a professor of applied economics at the University of Vigo, says the government's revenue estimates are overly optimistic, particularly its controversial one-off tax amnesty for individuals and companies hoarding cash and undeclared assets. "Research into past amnesties of this kind in Spain suggest we should be very cautious," he says.

The Economy Ministry says that its calculations are "cautious and reasonable." Revenue for this year is estimated at 119.2 billion euros, 14.28 percent up on last year, and which includes 12.2 billion in assorted tax hikes."

Meanwhile, the Bank of Spain is also pessimistic about Rajoy's deficit estimates. "The projected course of total revenues in the budget is subject to downside risks," The governor of the Bank of Spain Miguel Ángel Fernández Ordóñez told a parliamentary committee this month. Fernández Ordóñez said revenue estimates should be "prudent" as he confirmed the economy is now suffering its second recession since 2009. The economy will shrink 1.8 percent this year, according to the International Monetary Fund's latest forecast.

The government's plan to raise 2.5 billion euros from a tax amnesty is "particularly uncertain," Fernández Ordóñez told lawmakers in a session to discuss the budget, which was approved by the Cabinet on March 30 and is making its way through Congress.

Spending linked to unemployment benefits may also be more than forecast as the nation suffers the highest jobless rate in the European Union, at almost 24 percent, the governor said. If additional measures are needed, indirect taxes should be increased and temporary tax measures may have to be replaced by permanent ones, he added. Fernández Ordóñez also said the decision by the government not to present the 2012 budget until March 30 had further undermined international confidence.

"The doubts on the deficit goal created enormous worry as well as the presentation of the budget three months into the year, which was probably justified, but the markets didn't see it as justified," he said.  The IMF stirred up new doubts about Spain's current targets this week when it forecast a Spanish shortfall of six percent this year and 5.7 percent in 2013, almost twice the three percent pledged by the Rajoy government for next year.

 

Pensions: Rajoy's Achilles' heel

Earlier this year, the Social Security department announced that it would probably break even this year. But even if the Social Security's current account does go into the red, it doesn't mean that pensions and unemployment benefit will stop being paid. The system has savings of its own and access to other resources to a total of more than 70 billion euros.

The biggest doubt hanging over the Social Security's accounts is its ability to keep paying out pensions to retired people. Of the some 115 billion euros set aside for pensions, around 102 billion euros goes to contributory pensions, and many economists say that this isn't enough.

"It is an underestimation," says Miguel Ángel García of the CCOO labor union. The Social Security department estimates that this portion will increase 2.9 percent on last year, and around 2.3 percent on top of total spending. According to his calculations, the difference is more likely to be 4.5 percent, in line with the increase in the first months of the year, and taking into account that inflation could reach around 1.5 percent for this year.

García's figures are closer to those of Social Security itself, which puts the contributory outgoings at 104.9 billion euros, with inflation running at two percent. With those figures, Rajoy will find it hard to balance the books unless he does something that he criticized Zapatero for while in opposition, which is to freeze pensions, something that would further erode his already fast-waning popularity.

Calculating how much the cost of paying pensions this year will be involves three variables: inflation (pensions are indexed); the increase in the average pension; and the number of pensioners. The Social Security estimates a relatively low increase of 2.9 percent. The government announced a one-percent increase in pensions in its first Cabinet meeting. If inflation hits 1.9 percent by year-end, as most studies suggest, that leaves the government with just nine tenths of a point to play with. It seems not to have taken into account that there was a 1.5-percent increase in the number of pensioners in 2010, followed by a 1.4-percent rise in 2011.

The Economy Ministry says that for this year it expects an increase in the number of pensioners of just one percent, even though the Social Security's own figures estimate an increase of 1.6 percent. The Economy Ministry says nothing about the average increase in pension payments, which the Social Security puts at around 1.7 percent, nor does it take into account the possibility of higher inflation.

There are other causes for concern, for example the money required to pay people who take early retirement now that it is easier for loss-making companies to sack workers.

But Conde-Ruiz of the economic research group FEDEA says that the government need not worry unduly about payments to those forced into early retirement. "Early retirement will decline. It is clear that when the stock market falls or pension plans no longer offer high yields, workers delay retirement. What's more, if your children are without work, you are less likely to think about retiring."

At the same time, the worsening crisis has seen a sharp decline in the amount of money being paid into the Social Security system: at the end of 2011, there was a shortfall of 2.5 billion euros. Things are not looking much better in 2012, with employment set to rise by a further 3.7 percent.

As a result, the government says that there will be a 3.7-percent drop in payments into the Social Security system this year. The starting point is not the 105.3 billion euros collected in 2011, but the 110.4 billion it plans to spend on pensions. The government foresees collecting 106.3 billion this year, despite there being 630,000 fewer people working. If it had based its calculations on spending, the result would have been 101.4 billion euros.

The Secretariat of State for Budgets says that it estimates an increase in contributions of 850 million euros because it predicts a fall of 1.9 billion euros due to a drop in the number of contributors, which will be made up for by the 949 million euros that will come from increasing the contribution rate, along with 1.8 billion euros generated by combating fraud.

"This budget has been calculated as though we were still in September, and not in March, with spending already underway. We got it wrong in 2010," says the former secretary of state for social security in the Zapatero administration, Octavio Granado.

Based on the above figures, the Social Security system looks set for a shortfall of around 6.8 billion euros, around 0.7 percent of GDP; if inflation can be kept at 1.5 percent, and salaries are kept in line with government forecasts, the figure might be lowered to 5.5 billion euros.

Unemployment payments

The Social Security department is also responsible for unemployment benefit payments. In 2010, it paid out a record 32.2 billion euros, a figure that fell last year to 29.6 billion euros. The government says that the figure for this year will be 28.5 billion euros. "The figure reflects a reduction in spending on unemployment that began in 2011," says the Economy Ministry, adding that it is not due to paying out less money to the unemployed.

The figures show that applications for unemployment benefit increased by 18 percent in February this year.

Miguel García of the CCOO labor union believes that outgoings for unemployment benefit payments for this year will match those for 2011 because growing numbers of people's payments will run out in the coming months. Other analysts are more pessimistic, suggesting that the government faces a shortfall of three billion euros.

How to raise 47 billion from VAT without a hike

Finance Minister Cristóbal Montoro has so far put off raising the value-added tax rate. But the government's forecasts of raising more than 47 billion euros in VAT this year, 3.3 percent less than the previous year, are looking increasingly shaky as the economy slumps yet further into recession.

Last year saw a 0.4-percent increase in VAT takings due to the hike in the rate in 2010 from 16 percent to 18 percent, along with 0.7-percent GDP growth that year. But this year a fall of 1.7 percent is forecast. Consumption is in sharp decline, and is forecast to shrink by 3.1 percent. Rajoy's estimate is that he will have 2.3 billion euros in VAT revenue this year. Rubio believes that the prime minister is being overly optimistic: "With the job market worsening, and consumption and house purchases down, that VAT calculation makes no sense," he says.And then there is the regional question...

Spain's regional governments have incurred the ire of Brussels, as well as the international financial markets for failing to meet their spending limits last year. And the 17 semi-autonomous governments remain a great imponderable when trying to put a figure on spending for this year.

Before looking at their accounts, the European Commission wants to know why the regions overspent last year. The government's Fiscal Policy Council meets with regional finance chiefs in May, and will be looking to reach agreement and a commitment to stay within budget for this year.

Juan Rubio-Ramírez of Duke University asks why the government is to reduce transfers from the central government to the regions by 61 percent, "when the regions' own budgets foresee only a 12 percent fall in capital revenue."

State investment in the regions is being cut by a quarter and money for employment, health and education will be cut by almost 45 percent. The regions face some tough decisions, and will find it hard to decide where to make cuts: 60 percent of what they spend goes on health, education and social services.

Professor Antoni Castells, a former economy chief in the Catalan government, says that blaming the regions for the size of the deficit is "unfair and disproportionate and is simply about playing party politics."

The Economy Ministry points out that it is "essential to remember that any agreement on spending has to take into account that more than half of public spending is managed by regional governments." It adds that measures such as raising income tax will help local authorities. Rajoy has also said that regional governments that do not stick to their budget guidelines will have their finances taken over by Madris.

Spanish house prices are continuing to fall,

According to the recent statistics published by Tinsa. Their Spanish Real Estate Market Index shows a reduction of 9.2% during the first quarter of 2012 over the same period of 2011.

Tinsa’s index reflects the change in price per square metre of real estate using information gathered from more than 200,000 housing valuations made by the company annually. The data refers to both new and second hand properties.

The appraiser, who usually has data broken down into five major areas (‘Capitals and Major Cities’, ‘Metropolitan Areas’, ‘Mediterranean Coast’, ‘Balearic and Canary Islands’ and ‘Other Towns’), has taken “a step further to deliver a product with high statistical precision” and is now including Local Markets in the Index, which reflects the value of homes by autonomous communities and provinces.

In this new geographical division, Aragon led the declines between January and March with a fall in real estate prices in the region of 16.2%, followed by Navarra (-16%), Catalonia (-12.8%), Madrid (-11.7%) and Andalusia (-10.1%).

On the opposite side, the autonomous communities where properties depreciated less are the enclave of Melilla (-4.5%), Galicia (-5.2%), Asturias (-5.3%), Cantabria (-5.6%), Extremadura (-5.8%), the Canary Islands (-6%) and the Balearic Islands (-6.5%).

The remaining regions (Murcia, -9.6%, Castilla y Leon, -9.4%, Valencia, -9.2%, Castilla-La Mancha, -8.9%, and the autonomous city of Ceuta, -8.4%) recorded similar declines to the national average. “The Basque Country is not reflected in the list since the sample is not representative,” says Tinsa.

By province, the year-on-year decline in prices has also been widespread with the exception of Cuenca, where the variation was 0%. At the head of the decline in prices stood Almeria (-17.3%), followed by Huesca (-16.5%), Navarra (-16%), Lleida (-14%), Seville (-13.4%) and Guadalajara (-13.2%).

In addition to the aforementioned case of Cuenca, the housing prices have remained resistant to declines in Orense (-0.5%), Pontevedra (-1.7%) and Ciudad Real (-2.1%). The reductions in the first quarter of 2012 are highlighted for Madrid and in Barcelona, reaching 11.7%, and 12.4% respectively.

In total, house prices have become cheaper by almost 29% on average in recent years, reported the Director of Business Development and Marketing for Tinsa, Raul Garcia. Aragon, again, leads the ranking with a cumulative decline in the value of their property of 34.6%. Castilla-La Mancha follows with -33.9%, then Catalonia (-33.8%), La Rioja (-32%), Valencia (-30.2%) and Madrid (-30%). At the other end of the list are the autonomous cities of Melilla (-6.9%) and Ceuta (-12.8%), followed by Galicia (-15.5%), Asturias (-18.2%) and Extremadura (-19.1%).

By province, El Mundo reported that the largest negative percentage from 2007 to the first quarter of 2012 also appears in Almeria (-37.4%). Guadalajara (-36,%), Zaragoza (-36%), Toledo (-34.7%), Barcelona (-34.5%) and Tarragona (-34.5%), are the other provinces where properties have depreciated most in the last five years. The provinces with least declines are Lugo (-9.8%), Zamora (-9.7%) the autonomous city of Melilla (-6.9%) and Ourense (-5.7%).

Banks need 100 billon Euros

(Reuters) - Spain's latest credit rating downgrade has thrown into sharp relief the need to revive a banking sector that could need another 100 billion euros to cover bad debts in order to avoid exposing another weak flank in the euro zone crisis,

The options are clear: Spain's troubled banks seek fresh capital themselves, the government comes to their aid or euro zone funds are somehow pushed in their direction.

But while the need for new funds is pressing, policymakers have no clear idea how to proceed.

The problem is the banks are in no shape to attract investment, Madrid cannot offer much more help since a domestic bailout would worsen Spain's already parlous debt position, while Brussels rules out direct euro zone aid to banks.

Something will have to give.

Standard & Poor's cut Spain's rating by two notches to BBB+ late on Thursday, citing a budget deficit which is not falling as fast as planned and "the increasing likelihood that the government will need to provide further fiscal support to the banking sector".

A burst property bubble and a deepening recession have made it likely Spanish banks will need more money than previously thought to recapitalize. Left unchecked, the hole could push Spain towards a Greek-style bailout which the euro zone can barely afford.

Latest data show Spanish banks are carrying their biggest burden of bad loans since 1994. As the economy deteriorates, compounding households' problems in repaying debt, they are expected to need more than the extra 53.8 billion euros ($71 billion) the Bank of Spain has predicted.

Just how much is difficult to gauge.

"It's evident they are short of capital," said Andrew Lim, analyst at Espirito Santo in London.

Lim said the 53.8 billion euros buffer covers real estate loans alone, and estimated more than 100 billion euros more could be needed to provide for other loans on its books that could go bad.

Banks have already taken enormous writedowns on property holdings. The new concern is they are refinancing too many business and consumer loans which will inevitably turn sour, in order to avoid taking a hit in the near-term.

"It's a moving target as the economy contracts, but any guesstimate probably shows losses will rise," said Hank Calenti, credit analyst at Societe Generale, which sees a need for 70 billion euros in provisions, and that assumes no acceleration of the economic downturn.

 

The Spanish government is not burying its head in the sand.

Government and financial sources told Reuters this week that Madrid will force banks to move all their real estate assets into a special holding company within weeks, although details of the scheme are still being worked on.

It also has a deposit guarantee fund though that is now almost bare and Spain needs at least 20 billion euros to secure the sale of three bailed-out banks.

Buyers will not be tempted unless they get guarantees to cover future losses from rotten real estate assets and the government wants the banks to replenish the fund.

One option would be to issue bonds against future bank contributions but that would be putting further burdens on a financial sector that can ill afford them.

Tristan Cooper, Sovereign Debt Analyst at Fidelity Worldwide Investment, contrasted Madrid's approach with that of Ireland, which took a huge hit up front, although Madrid has pumped something like 18 billion euros into its banks.

"Spain has chosen a softer approach, asking the banks to clear up their own mess before the government pumps in cash. We may have reached the end of the road on that one," he said. "A decision point on bank support is approaching fast and this could involve asking the EU for help."

Ratings downgrades could accelerate that process by pushing up the cost of funding, for the government and the banks. Spanish 10-year yields broke above the pivotal six percent level again on Friday, following S&P's action.

"The rating matters. That can be a factor that may push Spain closer to external help," said Antonio Garcia Pascual at Barclays Capital.

Economy Secretary Fernando Jimenez Latorre stuck to the script, ruling out any use of EU funds to bail out the sector, saying Spain had enough capacity of its own and that any call on public funds would be "very limited".

WHAT GIVES?

The option which would save most face - allowing the Spanish government to avoid the stigma of seeking outside assistance as Greece, Ireland and Portugal have - would be for the currency zone's rescue funds to directly recapitalize banks.

However, euro zone officials say the currency bloc is unlikely to allow the ESM, the permanent 500 billion euro bailout fund that is to come online in July, to do so.

"Some people have this bee in their bonnet, but only on a personal basis. It will not happen," a senior euro zone official said, a refusal echoed by EU Economic and Monetary Affairs Commissioner Olli Rehn in a Reuters interview last week.

The ESM's treaty states it can lend to banks, but only via a government. Any change to the treaty would require a new round of ratifications by national parliaments.

The European Commission will present a plan to deal with failing banks in Europe before the June 18-19 summit of leaders of the world's 20 biggest economies in Mexico.

But that is a mechanism to thwart future, not existing, crises as it will require banks to pay into it, taking time to build up to a critical mass. Spain's needs are more pressing.

All that leads some analysts to think the Spanish government will have to prop up its banks, regardless of the impact on its debt-cutting drive.

"The government must come out soon to say how they will address them," said Gilles Moec, an economist with Deutsche Bank.

The creation of more than a trillion euros of three-year money by the European Central Bank, a chunk of which was devoured by Spanish banks, has bought time. Spain's central bank says their funding needs are met for this year and probably well into next, averting the prospect of a credit crunch.

That, though, is not a solution.

"Although liquidity positions have improved and ECB long-term funding brings a reprieve, Spanish banks need to continue to build their capital buffers so that they can freely access private funding markets," the International Monetary Fund said this week.

There is also, if ECB policymakers are to be believed, little prospect of them launching a new round of money creation.

Spain's banks themselves are taking different approaches. Santander took $1.3 billion of further losses on property assets this week while BBVA, said it would write down property investments later in the year.

Either way, investors are increasingly nervous. The cost of buying protection against a default on bonds issued by Spain's biggest two banks has risen.

As ever with the euro zone debt crisis, doing nothing is not an option. But it may take a while yet for policymakers to get there.

"Given the harsh austerity measures being imposed, the likelihood of a further bursting of the property bubble and the precarious situation of the country's overleveraged banks, it seems unlikely that the end of Spain's woes is anywhere near," said Stefan Angele, Head of Investment Management, Swiss & Global Asset Management.

"It may ultimately require a euro zone solution that is much bigger and more wrenching than the process in Greece." ($1 = 0.7559 euros)