MADRID -- The Spanish government's dilemma over whether to request a European bailout has become more acute following a downgrade of the cash-strapped country's credit rating.
Standard & Poor's cut its rating on Spain's debt by two notches to BBB- late Wednesday, leaving the country on the cusp of junk status, or non-investment grade. That could make it more expensive for the Spanish government to borrow money as it might scare some of its bond investors away.
As well as citing the deepening economic recession in Spain and rising levels of social discontent, the agency said the government's hesitation in requesting help was "potentially raising the risks to Spain's rating."
Though S&P's warning may nudge the Spanish government to make a bailout request sooner rather than later, rival agency Moody's has indicated it may cut its rating for Spain in the event of a bailout request.
"It would appear that when it comes to the rating Spain is a bit between a rock and a hard place," said Gary Jenkins, managing director of Swordfish Research.
The Spanish government was not immediately available for comment.
Madrid's main stock index, the IBEX, was underperforming its counterparts in Europe on Thursday, trading 0.4 percent lower.
However, the yield on the country's 10-year bond was more or less unchanged, just below 5.8 percent, as investors weighed up whether the country would tap a new facility from the European Central Bank.
Last month, the ECB announced a new plan to keep a lid on the borrowing costs of indebted countries like Spain. It said it would buy unlimited amounts of debt of struggling European countries. However, the governments first need to apply for a eurozone bailout and so far the Spain's has balked at the prospect.
Instead, the government led by Prime Minister Mariano Rajoy has introduced a series of austerity and labor measures in a bid to bring down its deficit and convince investors it can manage its finances without outside help.
If the Spanish government continues down that path, it will have to do so with a debt rating near, or even, below junk status.
Though it has raised around 90 percent of the money it needs to service its debts in 2012, Spain will have to tap investors for around (EURO)200 billion ($258 billion) in 2013.
"Not easy to raise that kind of money with that kind of rating when the economic data is likely to come in worse than government forecasts," said Swordfish's Jenkins.
Earlier this week, the International Monetary Fund forecast that the Spanish economy would contract 1.3 percent next year, more than double the Spanish government's own prediction.
Following discussions with French President Francois Hollande on Wednesday, Rajoy said the country was making important reforms and that those, combined with European solutions, would prove the IMF wrong.
"If we follow that strategy ... we'll see that the reality turns out to be better than the forecasts," Rajoy said.
The prevailing view in the markets remains that Spain will have to request outside help some time next year, possibly after regional elections later this year, given the scale of the task in hand.
"With a large proportion of their funding for the year already completed we expect them to have sufficient funds to hold out until regional elections are out of the way later this year, though redemption payments at the end of January may become uncomfortably costly to refinance if yields drift wider," said Elisabeth Afseth, an analyst at Investec.
Christine Lagarde, the head of the IMF, praised recent steps taken by the ECB and European governments, but voiced her concerns at the impact Europe's austerity drive was having on global growth. Earlier, this week the IMF downgraded its global growth estimates for this year and next.
Spain, alongside many other European countries, have slashed spending and raised taxes in order to get a handle on their debts and in an attempt to convince investors they have a strategy to get their house in order.
Pylas reported from London.