By DANIEL WOOLLS, Associated Press
MADRID (AP) — Spain insisted Friday it is financially stable because its heavily indebted regions are now meeting deficit reduction targets, but investors remained worried about the country's ability to rescue another part of its financial system - the banks - and kept the government's bond yields dangerously high.
The nation's 17 semi-autonomous regions - whose high debts have helped fuel fears about the country's financial future — will meet a target to get their collective deficits below 1.5 percent this year, Finance Minister Cristobal Montoro told reporters.
The regions, which function much like U.S. states, ran a deficit of 0.45 percent of GDP in the first quarter. When counting €5 billion ($6.2 billion) they received from the central government, they ran a balanced budget.
"This means that since the beginning of the year the government's plan is working," said Montoro.
Most of Spain's excessive deficits in 2011 — which at 8.9 percent were almost three times the EU limit of 3 percent — came from the regions' overspending.
Eight of the regions, including powerful Catalonia in the northeast, saw their credit ratings downgraded this week by the Fitch agency. Those that issue debt are paying high rates. Montoro said the government is close to completing a mechanism that will allow the regions to issue debt through the central government at lower rates.
But worries about Spain in recent weeks have centered mainly on its banks, which are sitting on massive amounts of soured real estate investments. Rescuing the banks could overwhelm public finances, pushing the government to need international aid itself.
Those concerns remained as strong as ever on Friday and one senior bank executive said that if the amounts of money needed to rescue the country's banking sector kept on getting bigger there would be no alternative to a European bailout, the first time the head of a bank has acknowledged such a possibility.
"The banking sector is now in an absolutely critical situation," said Maria Dolores Dancausa, chief executive of Bankinter SA, Spain's seventh-largest bank by market value. "With the figures needed to clean up the banks going each time higher it gets to look like there will be no choice," Dancausa said.
The interest rate on 10-year Spanish bonds was up another 0.02 percentage points to 6.47 percent, close to the 7 percent rate that forced Greece, Ireland and Portugal to ask for bailouts.
Despite the rise in borrowing rates, Montoro insisted the country can meet its debt obligations: "Spain has the ability to make good on that debt in its entirety."
Concern about Spain and the wider 17-country eurozone has shaken financial markets in recent weeks, pushing the euro to a 2-year low on Friday.
Spanish Economy Minister Luis de Guindos said this week that Spain and Europe were at a crossroads as speculation mounts over whether the country will need a bailout. The danger is that Spain's €1 trillion ($1.24 trillion) economy is too big for Europe to save — far larger than the economies of Greece, Ireland and Portugal combined.
Spain's banking sector is laden with soured investments on real estate and the government needs €19 billion to rescue just one lender, Bankia SA, at a time of recession and crushing unemployment of 24.4 percent.
"I don't know if we are on the edge of a cliff, but we are in a very, very difficult position," de Guindos said Thursday evening in a speech to business leaders in Sitges, a resort town near Barcelona. "The future of the euro is going to play out in the next few weeks in Spain and Italy."
Bond yields — a measure of investor confidence in a country's debt — were also very high in Italy, which has big debts and is in recession. Its 10-year bond yield rose stood at 5.73 percent late Friday afternoon after rising to 5.93 percent earlier in the day on fears that it could be affected by Spain's instability.
UBS Investment Research said there is no consensus that the Spanish banking sector in general needs a big recapitalization. It estimated the sector needs between €80 billion and €100 billion in new funds.
"The Spanish State should be able to sustain the recapitalization costs without losing control of its finances," UBS analysts said in a note to clients. "We recognize however that financing this intervention in current market conditions will be difficult."