With an â€œofficialâ€ unemployment rate of 24 percent, and the number of loans falling into default more than doubling in the past year, fears that Spain could be heading towards a sovereign default forced the countryâ€™s borrowing costs to rise sharply this week . The yield on 10-year Spanish government bonds trading on the secondary market rose to 6.1 percent Monday before falling slightly  to just below 6.0 percent midweek.
Spainâ€™s annual deficit remains nearly twice the 3.0 percent of GDP mandated by the Eurozone and despite a pledge to reduce the deficit, the government continues to rely on borrowing to bridge the revenue gap. However, economists suggest that as bond yields approach 7 percent, the likelihood of a sovereign default grows dramatically as, over time, the accumulated debt simply becomes too expensive to repay.
This is the very same scenario we saw with Greece and we all know how that worked out . Unless Spain can reduce its deficit , while simultaneously keeping yields within a sustainable range, its options are severally limited â€“ appeal to the European Financial Stability Fund (EFSF) for emergency funding, or default.
Neither option is particularly appealing.
For February, the percentage of bank loans held within the Spanish banking system deemed to be â€œnon-performingâ€ rose to an eighteen-year high of 8.16 percent. Just five years ago, the default rate was less than one percent.
The best estimate places the total value of at-risk loans very near 145 billion euros ($190.4 billion) with no sign of improvement anytime soon. The Spanish banking system clearly represents a risk to the economy and the potential for taxpayers being on the hook for this accumulated debt is yet another reason for investors to be wary of Spanish bonds.
The EFSF currently has a lending capacity of about 500 billion euros  ($656.5 billion) and is guaranteed by they Eurozone countries. However, Spanish authorities will only turn to the EFSF as an absolute last resort. It would essentially be an admission to the entire world that they have lost control of their economy and can no longer generate sufficient funds through the bond market to keep the country afloat.
The money would also come with a series of strings attached enforcing both deficit-cutting goals as well as other austerity targets. The Spanish government need only look to their counterparts in Athens and the violent protests gripping Greece to get a sense of what they could expect should they be forced down that road.
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