Spain is poised to unveil a new austerity program that threatens to trigger more street violence and deepen an already crippling recession, pushing the euro region's fourth-largest country closer to a bailout.
The centre-right government of Prime Minister Mariano Rajoy will unveil the austerity budget Thursday, just two days after thousands of protesters clashed with police in Madrid and the region of Catalonia announced a snap election that could be the opening shot of its bid for full autonomy.
The protests and the potential independence drive in Catalonia highlight how the wounded nation's economic and banking troubles, which began after its housing bubble burst in 2008, is morphing into a political crisis that has rattled Mr. Rajoy's government and those of his neighbours.
Other European Union countries fear Spain's financial collapse would spill into Italy and push Greece, itself paralyzed by a general strike that turned violent Wednesday, out of the 17-member euro zone.
The mounting troubles in Spain and Greece sent European markets, and the euro, tumbling Wednesday, while yields on Spanish sovereign debt surged.
The yield on Spanish 10-year paper rose a quarter of a percentage point to 6 per cent, the highest level since early September, when the ECB said it would buy unlimited amounts of sovereign bonds in an effort to bring down the borrowing costs of the most distressed countries in the monetary union.
"We are pessimistic about the chances of Spain to hold out without actual ECB/ESM intervention," said Deutsche Bank economist Gilles Moec, referring to the bank's belief that Spain will soon seek emergency help from the European Central Bank and the European Stability Mechanism (ESM) as its economy deteriorates.
Spain's economy shows no signs of hitting bottom. On Wednesday, in its monthly update, the Bank of Spain warned that gross domestic product continued to fall at a "significant rate" in the third quarter.
Thursday's budget is designed to bring some stability to Spain's finances, but some economists and strategists fear the additional austerity measures will only deepen the recession in a country virtually crippled by 25-per-cent unemployment, sinking housing prices, falling retail demand, rising taxes, a relentless flight of capital and a private-sector debt load that the European Commission considers way above the sustainable threshold.
The new budget will try to cut spending by more than €60-billion ($76-billion) by 2014 and reportedly may include taxes on stock transactions, "green" taxes and elimination of tax breaks. It appears job-creation and retraining programs will also be unveiled as the government tries to get hundreds of thousands of unskilled construction and casual workers back into the work force.
Previous austerity budgets have failed to return Spain to growth or reduce the budget deficit substantially. Last year, Spain's budget deficit was 8.5 per cent of gross domestic product, the highest among the largest euro zone economies (Italy's was 3.9 per cent). Its goal this year is a 6.3-per-cent deficit. On Tuesday, Madrid said the central government budget deficit from January to August was 4.77 per cent, suggesting the full-year target is unachievable.
Marshall Auerback, the Denver-based portfolio strategist for Pinetree Capital, thinks the Spanish economy is sinking even faster than most economists have predicted – Deutsche Bank forecasts a 1.5-per-cent contraction this year.
He believes that Spanish government's effort to unleash more austerity in Spain could intensify the political backlash, boosting Catalonia's desire for independence.
Catalonia, in Spain's northeast, is traditionally Spain's wealthiest region, responsible for about 20 per cent of GDP, and has been a net contributor to the Spanish budget. But is also highly indebted and has been forced to launch a severe austerity program of its own.