June 12, 2012

PARIS — Spain’s borrowing costs soared Tuesday to levels that have sent other euro members into the arms of international lenders, calling into question the viability of a bailout deal for Spain’s banking sector even as other troubled countries were weighing whether they could make similar rescue arrangements.

In the Spanish deal, reached Saturday, the government of Prime Minister Mariano Rajoy won $125 billion for recapitalizing Spain’s banking sector without putting the public finances under the full tutelage of international lenders.

But those terms are contingent on the government being able to continue tapping the bond market; if market rates rise too high, Spain could also end up needing a full international bailout.

On Tuesday afternoon, the yield on Spanish 10-year government bond soared 22 basis points to 6.69 percent, approaching the level that triggered bailouts for Ireland, Portugal and Greece. Italian yields also rose Tuesday, reaching 6.15 percent on the 10-year bond, up 14 basis points.

A downgrade by Fitch Ratings of second-tier Spanish banks, including Bankia, added to the pressure on Spanish bonds.

“Bailout lite has come and gone,” Rob Carnell, chief international economist at I.N.G. in London, said. “We got about three or four hours of respite.”

Mr. Carnell said euro zone leaders have been learning from past mistakes, and there were reasons to be optimistic that they would still meet the challenge ahead of them. But for now, the Spanish plan appeared to be a flop because “it doesn’t make Spain grow, it doesn’t address the government’s debt problem or the problems in the housing market.”

Encouraged by Spain’s banking sector rescue, Cyprus has begun preparing euro zone countries and its own public for the likelihood of a bailout application before it takes over the presidency of the European Union at the start of July, European officials and bankers said Tuesday.

Cyprus, with its own banking sector issues, would like to follow Spain’s lead, and quickly. Greek and Cypriot newspapers, citing European Commission sources, reported that a request was possible within a day, though a government official in the Cypriot capital, Nicosia, said Tuesday that no formal request had yet been made.

The tiny island nation’s government has been reticent about the subject, preferring to seek help from Russia rather than from its euro zone allies, because of the tough austerity measures that Greece, Ireland and Portugal have had to accept in exchange for bailouts.

“They are encouraged by what happened in Spain,” according to one European official, who spoke on condition of anonymity due to the sensitivity of the issue. “They were afraid,” he added, that there would be tough conditions, “a whole program.”

While Cyprus’s problems are pressing, more worrisome for officials and investors is the fear that Italy — the third-largest economy in the euro zone after Germany and France — will itself end up needing help.

The Spanish bailout has raised hopes in some of the countries that accepted more onerous conditions that they, too, will be able to get a break.

In Dublin, the Sinn Féin party’s finance spokesman, Pearse Doherty, said in a statement after Spain’s application that the loans were to be provided “at a lower cost, with no additional austerity or loss of sovereignty.” The Irish government, he added, should explain “why it was not able to secure these kinds of terms when the Spanish government could.”

In Greece, the two parties leading the election race, the conservative New Democracy and leftist Syriza, have suggested the Spanish pact was a sign that Athens could be cut some slack in renegotiating its own bailout. But Evangelos Venizelos, the former finance minister who negotiated the country’s debt deal with creditors and saw support for his socialist Pasok party crumble as a result, said Monday that the Spain deal showed European leaders were merely “preparing a firewall to deal with whatever happens in Greece.”

A bailout would make Cyprus the fifth euro zone member to need help since the currency bloc’s crisis began in late 2009, when the Greek government owned up to having grossly misled other governments about the size of the hole in its public finances.

The Republic of Cyprus has a population of just over 800,000, if the Turkish population of the northern part of the divided island is excluded, and an annual gross domestic product of about $24 billion. It is an offshore financial center with a banking presence much larger than its size would suggest.

That has been its undoing. Bank of Cyprus and Cyprus Popular Bank, the country’s two largest lenders, now need billions of euros to rebuild their capital after they had to mark down the value of their holdings of Greek government bonds and loans to Greek businesses and consumers.

Moody’s Investors Service has estimated that bailing out the banks would cost the government about 20 percent of gross domestic product. Analysts say there is no possibility of Cyprus being able to tap bond market investors for that amount.

Last year, Cyprus, frozen out of international debt markets, turned to Russia rather than the Union. The Russian government lent the government €2.5 billion at a below-market rate of 4.5 percent.

Finance Minister Vassos Shiarly told a parliamentary committee Monday that use of European Union aid was not necessarily “something bad or shameful,” the Cyprus News Agency reported, and said that officials had held discussions with the European Union about how the support mechanism operates.

“When a country appeals to the support mechanism, it considers everything, including the needs that might transpire over the coming period,” Mr. Shiarly said, holding out the possibility that Cyprus might seek a broader bailout.

But a government spokesman, Stefanos Stefanou, told state radio station RIK that, “if Cyprus seeks support from the mechanism, it will be for its banks and not for its financing needs.”

The European official said time was short because Cyprus is due to take over the rotating presidency of the European Union on July 1. “They don’t want to apply two or three days before the presidency,” he said.

Officials are also concerned about what effect the outcome of the Greek elections Sunday would have on the Cypriot banks and the perceived value of their Greek loans.

In afternoon trading in Europe, the Euro Stoxx 50 index, a barometer of euro zone blue chips, gave up early gains, falling 0.5 percent, while the FTSE 100 index in London fell 0.2 percent.

The Standard & Poor’s 500 index rose initially in New York trading, but turned negative in the first hour of trading.

The dollar was mixed against other major currencies. The euro fell to $1.2461 from $1.2482 late Monday in New York, while the British pound gained to $1.5532 from $1.5486. The dollar rose to 0.9634 Swiss francs from 0.9621 francs, and to 79.49 yen from 79.44 yen.

Asian shares were mixed. The Tokyo benchmark Nikkei 225 stock average fell 1 percent. The Sydney market index S.&P./ASX 200 rose 0.2 percent. In Hong Kong, the Hang Seng index fell 0.4 percent.

Stephen Castle reported from London. Jack Ewing contributed from Frankfurt, Paul Geitner from Brussels, and Niki Kitsantonis from Athens.

http://www.nytimes.com/2012/06/13/business/global/daily-euro-zone-watch.html?pagewanted=print