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Its reform-minded government has diligently swallowed the German austerity diet. <137>A man walks past an unfinished block of houses in the neighbourhood of Cancelada, near Estepona, southern Spain November 30, 2012. Spain's "bad bank" opened its doors on Friday with a blueprint broadly based on Dublin's National Asset Management Agency (NAMA) and a similar remit: to purge the country's lenders of toxic property assets that left them dangerously short of capital and reliant on European aid. Just like NAMA, SAREB - as the Spanish version is known - begins life accused both of paying too much for assets that have gone bad, and depressing the property market by acquiring them so cheaply. It has yet to attract private capital. REUTERS/Jon Nazca (SPAIN - Tags: POLITICS BUSINESS CONSTRUCTION REAL ESTATE) - RTR3B2AQ<252><137>

© Jon Nazca/Reuters/Reuters

Plenty of euro skeptics remain convinced that the single currency union has a bleak future. But apart from the most bearish of Brussels bashers, few people think it's in any immediate danger. And a growing number are convinced the worst of the euro crisis is in the rear-view mirror, even as the grim economic toll mounts in Spain and other fiscally challenged members of the club.

The European Commission's monthly confidence reading exceeded analysts' expectations in May, as business and consumer optimism picked up right across the 17-country euro zone. In Greece, where the crisis started, morale reached a five-year high, and sentiment also improved in beleaguered Spain, Portugal, Italy and France after a steep fall in April. "For the crisis countries, [the latest data provides] yet more signs that the worst is over. Southern Europe saw some of the strongest improvements," Christian Schulz, senior economist at Berenberg Bank, said in a note.

Yet the recession that has spread across a wide swath of the region deepened in the first quarter; and the jobless numbers continue to break records, topped in April by an astonishing 26.8 per cent for Spain, whose economy – the fourth-largest in the euro area – has shrunk for seven quarters in a row. Half a decade after Spain's housing bubble blew up, sinking much of the financial system, wiping out millions of construction jobs and driving the country into a huge fiscal hole, house prices and unemployment levels have still not reached bottom.

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Even the central bank is sounding more alarmist than usual. "After five straight years of job losses, unemployment has reached unacceptable rates, and the risk of chronic long-term unemployment is very worrying," the Bank of Spain declared in its annual report last week. Part of the cure is more labour flexibility, insists the bank, which advocates such political hot potatoes as a temporary suspension of collective-bargaining agreements and the minimum wage of €645 a month, if they impede more hiring.

Things are so bad in Spain that American rocker Jon Bon Jovi originally left the country off his band's European tour this summer, out of fear that cash-strapped fans wouldn't be able to afford the tickets. The musician subsequently changed his mind and agreed to do one concert in Madrid at lower prices, made possible when he waived his fee.

Here's another bad sign: Madrid's top public-health official is urging the government to lift its ban on smoking in public buildings for "economic reasons," to boost the chances of getting Las Vegas mogul Sheldon Adelson to construct a proposed convention, gambling and hotel complex called Eurovegas.

Yet there may be legitimate reasons for the improving confidence and for believing the euro zone has a future. More than any other country, Spain may hold the key to that future. Its reform-minded government has diligently swallowed the German austerity diet and indeed has been in no position to stop cutting. If all this doesn't lead to a turnaround, then other euro members may decide they are better off on their own.

"Spain is making some progress on slowing wage growth and boosting productivity, and exports have been doing quite well. But then you'd expect some of that in the context of a bad recession," says John Calverley, head of macroeconomic research with Standard Chartered Bank. "Productivity rises, because it's the marginal workers that get let go. And exports tend to do well, because you focus on where there's a market, and there isn't much of a market at home."

Still, Spain "has a long way to go, in terms of this competitive internal devaluation," says Mr. Calverley, co-author of a report gauging the progress made by four economies – the United States, Japan, Britain and Spain – in their recovery from the global financial crisis. All four suffered through the collapse of housing bubbles and related financial disasters. Spain was chosen for the study from among the other troubled euro zone countries, because it has the widest private-sector imbalances.

The solution to its plights have required extensive deleveraging, corrections in housing prices and restructuring of banking sectors. The U.S. is easily ahead in this race, while Spain has a firm hold on last place.

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Spain, Mr. Calverley concludes, is potentially "just halfway through a lost decade. It doesn't mean they'll be in recession the whole time, but when they see recovery, it might be just 1 per cent growth, 2 per cent at best." So there will be more pain and no quick employment recovery.

Yet the chances of Spain exiting the euro experiment range from slim to none. "Spain needs Europe. It doesn't want to be stuck out on a limb," he says. "Most likely, these things will be resolved over a very long time, with … quite difficult conditions."

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