Spanish financial markets were on alert for further disruption Wednesday, as the country's borrowing costs edged lower after soaring this week on fears the country might need a bailout.
The yield for Spain's 10-year bonds _ an indicator of the interest rate a country would have to pay to borrow on international debt markets _ dropped back to 5.81 percent according to FactSet, still close to Tuesday's four-month high of 5.93 percent and the levels that pushed Ireland, Portugal and Greece to seek a bailout.
Investors are growing concerned about Spain's finances for several reasons:
_ There are doubts that Spain will be able to lift its stagnating economy out of recession at a time when unemployment is nearly 23 percent.
_ The Spanish government has to cut its public deficit from 8.5 percent of its economic output to the maximum level set by the European Union of 3 percent by 2013.
_ The country's semiautonomous regional governments have been saddled with high amounts of debt and markets doubt they lack the budgetary discipline to turn their fortunes round.
_ Many Spanish banks have been crippled by bad loans following the collapse of the real estate market in 2008. There are fears that the Madrid government will have to step in and inject capital to save them from collapsing.
_ Spain makes up 11 percent of the 17-country eurozone's gross domestic product _ compared to Greece's 2 per cent _ and would therefore have a greater impact on the eurozone's finances should it seek a bailout.
The country's new right-leaning Popular Party government has introduced a series of labor and economic reforms aimed at convincing investors and the EU that Spain can slash its public deficit and not follow the path of Greece, Ireland and Portugal in seeking a bailout.
Speaking to reporters in Parliament, Prime Minister Mariano Rajoy said Spain's situation was "difficult and complicated."
"The government's economic policies are tough and costly and will not produce results in the short term but they are what we have to do in these moments," said Rajoy.
He said that Spain had overspent by (EURO)90 billion ($118 billion) last year.
"We have to ask (creditors) for this and if they don't give it to us it puts us in a difficult position," he said.
Adding to the country's woes are international investors' increasing reluctance to own risky investments, such as government bonds from Spain and other debt-laden countries such as Italy _ whose yield on its 10-year bond was 5.50 percent Wednesday, down from 5.7 percent on Tuesday.
The economies of Italy and Spain are the third and fourth largest in the 17-country eurozone after Germany and France and there is mounting concern that (EURO)800 billion firewall planned by the currency union's governments will not be strong enough to contain the fallout if Madrid or Rome asked for help.
Further gloomy news came for Spain on Wednesday as the National Institute of Statistics reported that industrial output fell for the sixth successive month in February. The institute said production retreated by 5.1 percent year-on-year in February, following drops of 4.3 percent in January and 3.5 percent in December.
IHS Global Insight economist Raj Badiani said the fall was expected.
"Clearly, Spain's pace of economic decline has yet to level off," he said in a note.
Rajoy's government came under attack Wednesday from opposition parties in a weekly parliamentary question session when opposition Socialist party leader Alfredo Perez Rubalcaba said the government's draft austerity budget with (EURO)27 billion ($35.4 billion) in tax hikes and spending cuts budget would "only worsen the recession."
But European officials expressed some sympathy for Spain's plight.
In Berlin, German Finance Ministry spokesman Johannes Blankenheim noted that Spain "has carried out wide-ranging reforms in many policy areas."
"We regret it that the markets so far are not appropriately rewarding these enormous reform efforts," Blankenheim said.
French government spokeswoman Valerie Pecresse described the fears over Spain's economic heath as "excessive.
"We think the government of Mariano Rajoy is carrying out a policy of courageous, necessary structural reforms, which can improve the potential growth of Spain and lead to a Spanish rebound," she said.
The rise in bond yields in Spain and Italy are also being seen as signs that the market-calming effects of a massive credit infusion by the European Central Bank are wearing off. The ECB made just over (EURO)1 trillion in emergency three-year loans to banks in two batches on Dec. 21 and Feb. 29.
The ocean of cheap credit removed fears of sudden bank failures, and eased borrowing for indebted governments as some banks used the cheap loans to buy higher-yielding government bonds. Bank officials have stressed that the measure was aimed at supporting banks _ not governments _ and that governments needed to use the respite to fix the eurozone's underlying debt problems.
Benoit Coeure, a member of the ECB's top executive board, underscored that message in a speech in Paris on Wednesday, saying that while ECB measures have helped avoid a credit cutoff to the economy the situation "remains fragile."
"Governments must build on the steps already taken to restore sound fiscal positions and support long term growth," he said.
David McHugh from Frankfurt, Geir Moulson from Berlin and Sylvie Corbet from Paris contributed to this report.