European officials may be set to receive a request from Spain for major funding, writes HONOR MAHONY

SPAIN IS facing a massive bank debt crisis. Economists suggest it is virtually inevitable it will have to go looking for money from the EU’s brand new euro-zone bailout mechanism. Meanwhile, markets are twitchy once again, and the press alive with rumours.

European officials at the beginning of the week angrily denied reports, first in the German and then the Spanish press, that an aid request from Madrid was imminent. Yet Spain, the euro zone’s fourth-largest economy, is undeniably the elephant in the living room in Brussels.

Spanish banks are borrowing from the European Central Bank at record levels as they struggle to get funding from the capital market. According to Daniel Gros, an economist at the Brussels-based Centre for European Policy Studies, it is “almost unavoidable” that Spain will have to make use of the recently established €750 billion-strong European Financial Stability Facility. “Spanish banks have been cut off. The spreads on German bunds are increasing all the time,” he says. “If Spain goes, Portugal will go too.”

Spain’s problems are of a different nature to those of Greece – the embattled euro-zone state for which a €110 billion International Monetary Fund-EU rescue package was agreed in May – and of a vastly greater order. While Greece’s woes can be blamed on an overspending government, Spain is suffering the consequences of a heady boom in construction, much like in Ireland.

When the sector collapsed, it pulled the economy down with it and the unemployment rate spiralled to 20 per cent.

Spain is now pushing through severe austerity measures to try to cut public spending. It has not gone unnoticed that the measures – a €15 billion package including lowering civil servants’ pay and freezing pensions – is similar to what the IMF would demand should Madrid come knocking at the institution’s doors.

EU leaders and Brussels policy-makers do not want to talk about Spain for fear of having an adverse effect on markets. But by not talking, the markets assume the worst-case scenario.

For the moment, other EU politicians have contented themselves with praising Spain’s austerity plan. “[The measures] are courageous and will be effective,” said European Council president Herman Van Rompuy.

Heading into their EU summit yesterday, leaders insisted Spain was not on the agenda. Afterwards, Mr Van Rompuy was keen to stress the “normality” of the summit compared to the crisis-driven gatherings of recent months. The one-day meeting focused on a growth strategy for the next 10 years and tightening the rules underpinning the euro – the stability and growth pact. But there were indications that Spain’s thunder-cloud presence is having an indirect effect on the discussions, as stress-testing banks has moved up the political agenda.

Mr Gros, who was the brains behind ideas for a European monetary fund, says credible stress tests are one half of the solution. The other is allowing for orderly defaults.

“What do you do if Spain comes to you and says I can’t guarantee all of my banks? Can you say no? The Germans are so furious because they cannot say no. In the end they have to say yes. They have no escape because we don’t have a sovereign default mechanism.”