By Jack Duffy

PARIS (MNI) – Spain’s Prime Minister Mariano Rajoy has vowed to
halt the country’s financial slide without outside help, but he is
quickly running out of options to do that.

Spain is trapped in vicious economic cycle where capital flight and
a tottering banking system are starving the economy of liquidity,
driving it deeper into recession and making it impossible to achieve the
deficit-reduction targets it has agreed to.

More than E66 billion in private capital left the country in March,
bringing the total for the first quarter to E97 billion. Deposits at the
nation’s banks fell by E31.5 billion in April, due entirely to
withdrawals by non-residents. Yields on Spain’s 10-year bonds have risen
by nearly 100 basis points in the past month to 6.6%.

Finance Minister Luis de Guindos said Thursday that the country was
in a “very, very, very difficult situation.” He told a told a conference
in Sitges, in eastern Spain, that “the future of the euro is at stake in
the next few weeks in Spain and Italy.”

With Europe’s debt crisis unextricably linked to its banking
crisis, it is time for Brussels to step in and halt the slide. A
possible way forward was outlined this week both by the European
Commission and European Central Bank President Mario Draghi.

The Commission suggested, with surprising boldness, that Europe’s
bailout funds might be able to provide capital directly to ailing banks.
Although Germany has opposed this, arguing that funds can only be
provided to governments on the basis of strict conditionality, Draghi
let it be known that the proposal is very much alive.

“We can have a big pot of money, but if no one can touch it, it is
not going to work,” Draghi told a European Parliament committee on
Thursday. “People are working on finding ways how the ESM could be used
to recapitalize banks,” he said, referring to the European Stability
Mechanism.

By taking direct stakes in banks through its bailout funds, the
Eurozone would be taking an important step toward breaking the link
between weak sovereigns and weak banks by forming a banking union.

The other pillars of the banking union, as described by Draghi on
Thursday, would be a pan-European deposit insurance program to stop
deposit flight from the periphery, a European bank resolution fund to
deal with “too-big-to fail” banks that are on the point of failing, and
a single European banking regulatory authority to coordinate it all.

The problem with all these solutions is that they take time to
implement, and time is one thing that Spain does not have. The collapsed
mortgage lender Bankia needs E19 billion in fresh capital and the
Spanish banking system overall may need as much as E120 billion. A
number of Spain’s autonomous regions like Valencia need financial
support from the central government or they could default on their own
debts.

“The time is ticking for Spain, which increasingly looks like an
ailing boxer staggering from one corner to the next trying to avoid the
final knockout punch,” said Tobias Blattner, economist at Daiwa Capital
Markets, in a research note earlier this week.

Spain has understandably refused the kind of official assistance
that left Greece, Ireland and Portugal with growth-killing austerity and
far more debt than they ever anticipated. But the longer the uncertainty
around Spain is allowed to prevail, the more the liquidity knot will
tighten.

At their summit on June 28 and 29, European leaders need send a
signal that they are in Spain’s corner and that they will do whatever it
takes to save it from that final knockout punch.

(EuroView is an occasional column written by Market News International
editorial staff. Any views expressed are solely those of the writer.)

–Paris newsroom. +33142715540; jduffy@marketnews.com

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