Investors punished Spain's bonds as early euphoria over a euro zone loan to rescue stricken banks transformed into deep concern over its growing debt.
Spain's euro zone partners agreed on Saturday to extend up to €100 billion to salvage a banking sector weakened by reckless lending in a property market that crashed in 2008.
The rescue, which represented a U-turn by Madrid, eased concern about the risk of a Spanish financial sector calamity.
But the sheer size of the loan fed anxiety over Spain's fast-growing public debt.
Spain's 10 year government bond yields eased at first, but by mid-afternoon they had surged to 6.424% - well above Friday's close of 6.216%.
The risk premium - the extra rate investors demand to hold Spanish 10-year government bonds over their safer German counterparts - shot to 5.08 percentage points after closing last week at 4.89 percentage points.
A rally on the Madrid stock market also wilted.
After soaring by 5.9% in opening trade, the IBEX 35 index of leading shares closed 0.5% lower this evening.
Spain's Treasury had sought to ease concerns over the impact of the rescue loan on Spain's sovereign debt. Far from undermining Spanish public debt, it would "reinforce its overall solvency," the Treasury said in a joint statement with the Economy Ministry.
Spain vowed to carry on tapping the debt markets after raising 56.8% of the total €86 billion it plans this year through regular auctions of medium and long-term bonds. A formal request for the rescue loan is expected by the next euro zone finance ministers meeting scheduled for June 21, European Economic Affairs Commissioner Olli Rehn said yesterday.
The final figure will be known after the European Union, European Central Bank and IMF finish a review of the situation and a formal accord will then be signed, he said.
A report by Barclays Capital analysts said that a loan of €70-80 billion would push up Spain's public debt by 7-7.5 percentage points from the end-2011 level of 68.5% of economic output. Under this scenario, Spanish public debt would likely peak at 95% of economic output by 2015, they predicted, meaning that fundamentally the state would remain solvent.
"However, the problem confronted by Spain and the rest of the periphery is bigger," the analysts said, warning that the crisis could not end while there remained a risk of fragile economies leaving the euro zone.
Spain's Prime Minister Mariano Rajoy said yesterday that the deal ensured "the credibility of the euro" and insisted that rather than buckling to pressure for the rescue, he had sought it all along. His government has vowed to slash Spain's public deficit from 8.9% of total economic output last year to just 5.3% this year and 3% in 2013.
But economists say Spain faces a daunting task achieving those goals in a period of recession, which cuts on tax income, and with unemployment at 24.4%, which raises welfare costs.
Spain will be under Troika supervision - Almunia
Spain faces supervision by international lenders after a bailout for its banks agreed at the weekend, EU and German officials said today, contradicting Prime Minister Mariano Rajoy who had insisted the cash came without such strings.
Rajoy said yesterday that Madrid had scored a victory by securing aid from euro zone partners without having to submit to a full state rescue programme, saying Spain's rescue had "nothing to do" with the procedures imposed on Greece, Ireland and Portugal.
But EU Competition Commissioner Joaquin Almunia and German Finance Minister Wolfgang Schaeuble said that as in those other bailouts, a "troika" of the International Monetary Fund, the European Commission and the European Central Bank would oversee the financial assistance.
"Of course there will be conditions," Almunia told Spanish radio. "Whoever gives money never gives it away for free."
Spanish state finances are already under European Commission surveillance under the EU's excessive deficit procedure.
Dutch Finance Minister Jan Kees de Jager said in a letter to parliament that the loans would add to Spain's public debt, and he had insisted on full IMF involvement.
"It was essential for the Netherlands that the IMF will be involved in the whole process: reviewing the formal support request, determining the conditions, and monitoring progress," he wrote.
The Spanish government said it would stick to this year's borrowing programme on financial markets. Spain still needs to refinance €82.5 billion of debt maturing by the end of the year, with a big hump at the end of October, and the autonomous regions have a further €15.7 billion of debt maturing in the second half of 2012.
The central government and the regions also have to fund a deficit of about €52 billion this year.
The bank rescue package will add up to 10 percentage points to Spain's debt-to-gross-domestic-product level, taking it close to 90%, while the country faces a grinding recession, with nearly one worker in four unemployed.
Some economists believe Spain will eventually need a full state bailout, and that Italy may be next in line because of a similar combination of high debt and no economic growth, despite reforms initiated by Prime Minister Mario Monti.
Spain vows more austerity, reforms
Spain vowed today to pursue austerity and economic reforms after securing a euro zone rescue for its stricken banks of up to €100 billion.
The Treasury stressed that the vast loan would strengthen the solvency of Spanish public debt, and said it was committed to carrying on its programme of bond auctions to raise financing.
Keen to show no let-up in the government's austerity drive and to banish concerns about the loan, which raises Spain's overall public debt, the Economy Ministry and Treasury issued a joint statement.
"The Spanish government remains committed to the programme of fiscal consolidation and structural reforms that has earned Spain the confidence of its European partners," it said.
"The Spanish Treasury reaffirms its commitment to capital markets and will therefore continue to execute its funding programme through its regular auction calendar," it added.
The Treasury has already raised 56.8% of the total €86 billion it plans to rake in this year through regular auctions of medium and long-term bonds to finance the state.
Borrowing €100 billion in one go would raise Spain's public debt level by about 10 percentage points of gross domestic product.
"This financial assistance will not only not undermine the present conditions of the current stock of Spanish public debt; it will also reinforce its overall solvency," the statement said. "Furthermore, a sound and duly capitalised banking system will reduce future contingent liabilities of the state and will therefore reinforce the sustainability of Spanish debt," it said.
The upper limit of €100 billion "guarantees a credible backstop," it said, providing enough to cover any capital needs in the "most stressed hypothetical scenarios" plus an additional buffer.
Madrid stressed there were no new conditions for the broader Spanish economy. "The agreement will only entail the necessary policy conditionality pertaining to the financial sector, and does not require any additional commitments on fiscal consolidation and structural reforms than those already in place," the government said.
Format of Irish bailout ''a mistake''
A former special advisor at the Department of Finance, Dr Alan Ahearne, has described the format of the Irish bailout deal as a mistake.
Dr Ahearne said it would have been better if the bailout funds had gone directly into the Irish banks and not to the State to put into the banks.
He said the Spanish bailout deal is very similar to Ireland's programme in that money has been lent to the Spanish government to be put into its viable banks. He said it differs to the Irish one in that the Spanish government has not received a separate pool for state funding.
Instead the Spanish government is hoping to fill the gap in its budget deficit by going to the markets to borrow money.
Dr Ahearne said Spain is hoping now that sentiment improves and that it can get the cost of its borrowing down. Up to this, anybody buying Spanish bonds was taking a gamble on the losses in the Spanish banks and this was putting off investors.