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Can Spain Avoid Greece’s Vicious Circle?

Spain is at risk from many of the problems which beset Greece in the run up to its bailout by international lenders.

Flag of Spain
Carlos Sanchez Pereyra | Photographer's Choice | Getty Images
Flag of Spain

“What they’re going through seems like the Greece situation a couple of years ago, and there are concerns that if it’s not addressed soon enough, it could move further to the same vicious cycle,” Thanos Papasavvas, strategist at Investec Asset Management, told CNBC Europe’s “Squawk Box” Wednesday.

The country’s economy is in recession, confirmed by the latest second quarter GDP (CNBC Explains) figures released on Tuesday, which showed the country’s economy contracted for the third quarter in a row, and by 1.3 percent from the same time in 2011. Deposit flight is an increasing problem for the country’s already struggling banks as deposits fell by 4.7 percent from June to July. (Read More: Spain's Recession Deepens)

Youth unemployment is now over 50 percent – although this probably conceals some people who are being paid off the books.

In Spain’s favor are a “credible austerity plan” and “some progress on structural reforms, particularly in the labor market,” according to Papasavvas.

“They still need economic growth. They need to reduce borrowing costs for the government, which will also help reduce borrowing costs from the private sector, until the reforms that they’ve taken start bearing fruit,” he added. (Read More:Spain May Not Need Full Bailout)

Papasavvas argues that the deficit is the over-arching problem in Spain, not the debt-to-GDP ratio, which is smaller than that of many peripheral countries. He says the main reason Spain is failing to meet its deficit targets are problems in its regions.

On Tuesday, Catalonia became the latest region to ask for a lifeline from the Spanish government when it asked for 5 billion euros ($6.2 billion) to shore up its banks, from the 100 billion euros the troika of the International Monetary Fund (IMF), European Central Bank (ECB) and European Commission has lent Spain.

“This aid request was very much expected. The debt load that the regions have is a relatively small part of the debt ratio in Spain,” Otto Dichtl, managing director at Knight Capital Group, told CNBC.

Dichtl is overweight on the bonds of Spanish regions, a contrarian call – and he argues that it is better for them to be structurally subordinated through the bailout than be the senior debtor in a defaulting or restructuring situation.

“Spain has been strangling spending in the regions for some time. It has its own euro crisis – in the same way the euro zone cannot control spending in the periphery, Spain has its own problem in the regions,” Papasavvas said. “Starting next year, they will need some kind of support.”

Spain’s Prime Minister Mariano Rajoy denied that his country needs a bailout, beyond the existing banking bailout, on Tuesday. “There isn’t any negotiation about this issue,” he told a press conference in Madrid after holding talks with visiting European Council President Herman Van Rompuy. “Because we have not made a request…we are not negotiating anything.” Rajoy will meet French President Francois Hollande on Thursday.

The Spanish Prime Minister will be aware that every other euro zone government which has gone for a bailout has been ousted in elections soon afterwards. While he may not want to share the fate of Ireland’s Brian Cowen, Portugal’s José Sócrates or Greece’s George Papandreou – failure to deal with his country’s fiscal problems may land him in the same boat anyway.

Its sheer size and relative importance in the grand euro zone scheme, relative to much smaller Greece, may ultimately be Spain’s best bargaining chip. (Read More: Could Spain's Banks Be Saved By Letting Some Go Bust?)

“Spain will have the time to negotiate very hard,” Papasavvas pointed out.

Market rumors that the ECB will intervene in the bond markets to buy Spanish bonds and keep Spanish bond yields below danger levels, a method of action which wasn’t employed for Greece, have restored some faith in Spain’s future. The country sold short-term bills at a successful bond auction on Tuesday.

Of course a bailout for the country is likely to come with conditions attached to satisfy countries such as Germany which are contributing to the new European Stability Mechanism bailout fund. (Read More:New Euro Bailout Fund Could Fall Short)

Nevertheless, Erik Nielsen, global chief economist at Unicredit, hailed the potential move because it will help get Germany on board, even though he thinks the ECB is going outside its remit.

“A central bank shouldn’t really set conditionality for a government. It’s appointing a bureaucracy of technocrats,” he said. “Still, it’s realpolitik and this is the way to get the Germans on board – so in the real world, it’s really smart.”

Written by Catherine Boyle, CNBC. Twitter: @catboyle01

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