Reasons Not to Lose Faith in Spain…Yet

Spain is in turmoil once again and the besieged European country is closer to asking for a financial bailout, but, perhaps investors should cut Madrid some slack, analysts say.

Flags of the EU member states fly in front of the European Parliament in Brussels.
Georges Gobet | AFP | Getty Images
Flags of the EU member states fly in front of the European Parliament in Brussels.

The Spanish government is taking tough measures to end the country’s debt crisis and the 2013 budget, expected to be outlined later on Thursday, could go some way to easing investor concerns, they add.

Protests against austerity measures hit Spain’s capital city for a second night on Wednesday, while fears that Spain cannot get its finances under control have triggered a renewed jump in government bond yields and a sharp sell-off in Spanish stocks – a move that has had ripple effects across global markets.

While Spain still has a long road ahead, even with a rescue package, there are some reasons to be positive, strategists say.

“I think the clashes in the streets are an indication that structural, labor market, regional reforms are for real. But that should also tell investors to not underestimate the amount of effort Spain is putting in with stringent measures to make sure they make it,” Adolfo Laurenti, Deputy Chief Economist at Mesirow Financial in Chicago told CNBC Asia’s “Squawk Box.”

“Having spent some time in Spain, and knowing the situation in Italy as well, I know there is a very strong commitment in those countries to make it work. And I think that’s what many observers from far away are underestimating,” he added.

Spain on Thursday is expected to unveil further cutbacks and measures such as limits on early retirement and new taxes on greenhouse emissions to reassure investors that it is trying to get its fiscal house in order. The government has also said it will create an independent fiscal authority.

“This budget that they going to introduce will be the fourth round of belt tightening in less than a year,” Kathy Lien, Managing Director at BK Asset Management in New York said on Squawk Box.

Ben May, an economist at Capital Economics, said Thursday’s 2013 budget could provide some positive signs for jittery markets.

“If it includes measures which the IMF and European Union have previously recommended, such as further structural reforms to labor and product markets, the government might avoid having to implement new policy measures to receive a bail-out in the future, paving the way for a deal to be put in place quickly,” May wrote in a research note.

Hard Times

Spain is widely anticipated to ask for a financial bailout from the euro zone – something the European Central Bank has stressed Madrid must do before it steps in to help the troubled country by buying its government bonds. Yields on Spanish bonds jumped above 6 percent on Wednesday, heading back to levels viewed as unsustainable.

Prime Minister Mariano Rajoy faces pressure from Europe’s policy makers to take harder measures such as freezing pensions. Data released earlier this week showed Spain will miss its public deficit target of 6.3 percent of GDP this year, while the country’s central bank said on Wednesday the economy contracted sharply in the third quarter.

On Friday, the results of an independent audit of Spain’s banking sector will show how much money will be needed from a 100 billion euro ($130 billion) aid package for the banks already approved by Europe.

According to May, the announcement also has the potential to give markets a positive boost.

“This might reveal that the banks need capital injections of perhaps 40 billion to 60 billion euros to restore them to full health, much less than the 100 billion that has been set aside … Not only would this be good news for the Spanish public finances, it would also leave the bail-out facilities with more firepower to tackle the region’s other problems,” he said in the note.

Analysts agreed that to really restore faith, Spain would need to ask for a financial bailout, something it is seen as reluctant to do because of the political backdrop at home and conditions that may be attached.

(Read More:Spain Nears Bailout - But What's Different This Time?)

“Now it’s up to Spain to deliver on reform and that would be more credible if they took the European bailout money,” said Laurenti.

That view was shared by Lien, who said: “Investors want Spain to request a bailout and unless it does, they will continue to attack those bond yields and the euro to try and force the Spanish government into that direction.”

“So when the announcement comes, and I think it is pretty inevitable, that will be positive for the euro and lift Spanish bonds as well. But up until then, there will be more pain for the euro,” she added.

—By CNBC's Dhara Ranasinghe; Follow Her on Twitter @DharaCNBC