Spanish Prime Minister Mariano Rajoy has spent much of thepolitical capital he won seven months ago in the biggest landslidein 30 years, floundering against a crisis that risks making Spainthe first $1 trillion economy to need a sovereign bailout,investors and analysts say.

Rajoy, singled out by leaders at the Group of 20 summit, hasbeen taunted by opposition lawmakers and commentators as borrowingcosts soared to a euro-era record even after Spain's banks receiveda 100 billion-euro ($127 billion) lifeline. Rajoy called the rescuea victory that solved lenders' problems.

“He clearly doesn't get it,” said Gary Jenkins, founder ofSwordfish Research Ltd. near London, who has tracked bond marketsfor more than 15 years. “Spain needs someone who can come in andgrasp the seriousness of the situation and react to that, not justpretend everything's okay.”

Spain may be able to stave off a full bailout for as much as 12months as domestic banks support treasury bond auctions, accordingto Fidelity Investments's Jamie Stuttard. Alessandro Giansanti atING Bank NV said it may come by September.

“The next three months will be the path to the bailout,”Giansanti, an Amsterdam-based interest-rate analyst, said in atelephone interview on June 19.

The yield on Spanish 10-year debt was little changed basispoints to 6.61 percent at 12 p.m. today in Madrid, pushing the riskpremium over German bunds to 507 basis points. Italy's benchmarkyield rose 6 basis points to 5.81 percent.

The Spanish-bank bailout made Italy the next potential investortarget. Together, they could overwhelm the sums committed tosafeguard the 17-nation currency bloc. Southern Europe's two majoreconomies have 2.8 trillion euros of government debt, four timesthe total of Greece, Portugal and Ireland.

“A rescue for Italy is pretty much impossible without a majorchange in German borrowing costs, a major change in overalleuro-zone levels of inflation, a major change in the level of theeuro, or a major change in the structure of the euro zone,”Stuttard, Fidelity's head of international bond portfoliomanagement in London, said in a telephone interview on June 19.

Bank Needs

Rajoy, 57, who was told by Germany's Angela Merkel at the G-20in Mexico June 19 to spell out the depth of his banks' needs “assoon as possible,” will be under scrutiny today when he facesMerkel and French President Francois Hollande at a meeting in Romehosted by Italy's Mario Monti.

The contrast between the unelected Monti, praised by globalcounterparts for his bid to bring order to Italy's finances, andRajoy, who came to power just weeks later, is underscored in thebond markets.

When Rajoy took office in December, Italy's 10-year yields weresurging above 7 percent and comparable Spanish debt traded as muchas 200 basis points lower. Now, Spain's 10-year notes yield 81basis points more than Italy's.

The International Monetary Fund June 8 urged Spain that devisingan “effective communication” strategy is “critical” for financialstability.

“The Spanish problem was entirely avoidable,” said Thomas Mayer,a Frankfurt-based economic adviser to Deutsche Bank AG. “This hasbeen created by miscommunication.”

The run-up to the bank bailout was marked by policy reversalsand self-contradictions by Rajoy, who lost two general elections inSpain before ousting the governing Socialist Party in November.

Rajoy called for the euro region's rescue fund to recapitalizedistressed lenders on May 28, even as he argued that Spanishlenders won't need external support. On June 2, he called on euromembers to give up sovereignty over their budgets to cement afiscal union, reversing his stance from three months earlier.That's when he said budgets were a sovereign matter as he defieddeficit commitments to the European Union.

The following week, he left it to Economy Minister Luis deGuindos to explain the bank rescue. Eighteen hours later, withSpaniards posting criticism on Twitter with the hashtag#RajoyCobarde — Rajoy, coward — and El Pais newspaper accusing himof hiding, the premier spoke to the press.

Rescue Winners

“Yesterday, the credibility of the euro won, yesterday thefuture won,” he said on June 10. “Yesterday, the European Unionwon.”

Then, he announced that since the banks' funding problems wereresolved he would continue with his plans to watch the nationalsoccer team play that night and climbed aboard his government jetto fly to the Polish city of Gdansk.

“People were astonished that he was going off to Poland,”Jonathan Tepper, a partner at London-based investment research firmVariant Perception, said in a telephone interview. “Things likethat make him look completely incompetent.”

A spokeswoman for Rajoy who asked not to be named said thepremier wanted to be clear the June 9 agreement was not a bailoutfor the sovereign and he wasn't denying reality. Spain has not beendragging its feet over the aid request since the official positionhas been that they would wait for yesterday's stress-test resultsto decide how much capital would be required, she added.

Spanish 10-year government bond yields rose as much as 76 basispoints in the week that followed, the biggest weekly gain since1997 and commentators and rival politicians mocked Rajoy forrefusing to acknowledge that the loan deal was a bailout.

“Say it with me, it's – a – res – cue,” Rosa Diez, leader of aminority group, taunted the prime minister in parliament. “Nothingbad's going to happen if you say it.”

Rajoy's budget cutting faces virtually no reduction in the350-member parliament, where his People's Party has 185 seats.

Still, his standing with the public has taken a beating. A pollconducted for El Mundo by Sigma Dos between June 12 and June 14showed Rajoy's disapproval rating doubled to 43 percent fromJanuary.

In Mexico, World Bank President Robert Zoellick said it wasn'tall Rajoy's fault, criticizing Europe's leaders for fumbling thebailout.

“To have that being a negative story is amazing” given theamount of money pledged, Zoellick told a June 17 panel discussionat the meeting in the Mexican resort of Los Cabos. “The executionwas extremely poor.”

Bloomberg News

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