Markets punish Spain with record premium after Valencia seeks aid

Spain’s risk premium shot to a new record high on Friday after officials in Valencia formally asked the central government for funds to help pay the region’s mounting bills, including the high prices of prescription drugs.

The cost of servicing Spanish debt rose to 7.26 percent after mid-afternoon with the risk premium hitting the 612 basis points mark and closing at 610 basis points over the benchmark German bund.

Spanish stocks also took a beating, with the Ibex 35 dropping 5.82 percent — its biggest plunge since May 14, 2010 when the Greece rescue package was announced and then-Prime Minister José Rodríguez Zapatero unveiled a series of austerity measures. The blue-chip index closed on Friday at 6,246.3 points.

Following the weekly Cabinet meeting, Finance Minister Cristóbal Montoro announced that the government was cutting its economic growth forecasts for 2012 and 2013 based on the rise in interest rates Spain will have to pay for its debt, hikes in Social Security costs and increases in pensions. The minister said that public spending could rise by as much as 9.2 percent in 2013.

The minister also predicted that the unemployment rate would rise to 24.6 percent by the end of the year — up slightly from April’s figure of 24.3 percent. Nevertheless, Montoro forecast a slight decrease of between 24.2 percent to 24.3 percent for next year. Things will start to pick up in 2014, he said, when unemployment is expected to drop to 23.3 percent and in 2015 with 21.8 percent.

Valencia is Spain’s most indebted region followed by Catalonia and Andalusia

At first, Montoro said that he wasn’t aware that Valencia government officials had announced about an hour earlier that they would be the first region to formally tap into the Regional Liquidity Fund (FLA), a system that was created just over a week ago that allows cash-strapped regions to access financing but under stringent guidelines.

“Valencia is not getting a rescue,” said deputy regional premier José Císcar during his own news conference. “We are tapping into a mechanism of financing that more regions will be using in the coming days, but without any more adjustments.”

After first denying it, Montoro explained that the region will tap into FLA and would indeed “be obligated to follow new conditions.”

Císcar declined to put a figure on how much Valencia would need, but some financial forecasts show the region may require as much as three billion euros in emergency funding.

The proposed 18-billion-euro FLA reserve will be financed mostly by state-administered public debt, plus a loan from the national lottery agency to the tune of six billion euros.

Valencia is Spain’s most indebted region, followed by Catalonia and Andalusia. Last May, Catalan premier Artur Mas publicly asked the central government to come up with a mechanism to help regions pay their bills.

Also on Friday in Brussels, euro-zone finance and economy ministers approved the terms of a loan of up to 100 billion euros that will be available to recapitalize Spanish banks. The exact amount required won’t be known until September after the results of in-depth audits are known.

Under the terms, Spain will have to restructure its banking sector and improve governance and regulation, the Eurogroup said in a statement. Madrid will also have to abide by its deficit-reduction pledge and commitments to structural reforms.

EU Economic and Monetary Affairs Commissioner Olli Rehn stressed Spain was expected to bring its budget deficit below 3 percent of GDP in a sustainable manner by 2014.

The agreement came shortly after the Finnish parliament approved granting Spain its portion of the bailout. On Thursday, the German parliament also voted in favor of granting Spain the funding.