Rajoy Inches Toward Aid as Protests, Regions Seethe

Violent protests in Madrid and growing talk of secession in wealthy Catalonia are piling pressure on Spanish Prime Minister Mariano Rajoy as he moves closer to asking Europe for rescue money.

Rajoy has been resisting calls from influential domestic bankers and the leaders of France and Italy to move quickly to request assistance, but a series of events this week will drive him closer.

With protesters stepping up anti-austerity demonstrations, Rajoy presents more painful economic reforms and a tough 2013 budget on Thursday, aiming to persuade euro zone partners and investors that Spain is doing its deficit-cutting homework despite a recession and 25 percent unemployment.

Fresh data on Tuesday suggested Spain will miss its public deficit target of 6.3 percent of gross domestic product this year, as the central government deficit reached 4.77 percent at the end of August, already higher than the year-end target.

By front-loading the reforms Rajoy hopes to sell them to voters as home-grown rather than conditions imposed from outside. Diplomats reported intense last-minute pressure on Madrid from key euro zone policymakers to take tougher measures, notably on freezing pensions.

On Friday, Moody's will publish its latest review of Spain's credit rating, possibly downgrading the country's debt to junk status.

On the same day, an independent audit of Spain's banks will reveal how much money Madrid will need from a 100 billion euro ($129.62 billion) aid package that Europe has already approved for the euro zone's fourth biggest economy.

Spain's reluctance to seek a sovereign bailout - a condition for European Central Bank intervention to cut the country's borrowing costs - could propel the euro zone into deeper trouble.

Rajoy moved one step closer to requesting aid, suggesting in an interview with the Wall Street Journal published on Wednesday that he would make the move if debt financing costs remained too high for too long.

"I can assure you 100 percent that I would ask for this bailout," he told the newspaper, calling the situation he faces right now "fascinating."

He also said he had not made his mind up on whether to maintain inflation indexation of pensions, which could cost the state an extra 6 billion euros this year.

"We need to be sufficiently flexible in order not to create any further problems," he said when asked about pensions.

His comments helped drive the premium investors demand to hold 10-year Spanish debt rather than benchmark German bonds up to 445 basis points on Wednesday, the highest level since early September.

Markets were also reacting to a letter from Germany, Finland and the Netherlands on Tuesday that implied that rescue funds Spain receives for its banks will remain on its public debt. The three said any future direct recapitalisation of banks by the euro zone's bailout fund should not cover "legacy" problems.

CATALONIA INDEPENDENCE MOVEMENT

The government's drive to rein in regional overspending as part of its austerity measures has prompted a flare-up in independence fervour in Catalonia, the wealthy northeastern region that generates one-fifth of Spain's economic output.

Just as the euro zone crisis has strained relations between wealthier nations of the north and heavily indebted countries to the south, Spain's crisis has aggravated tensions between the central government and its self-governing regions.

Catalonia is broke and needs a 5 billion euros bailout from the central state to meet debt payments this year, but Catalans are convinced they bear an unfairly large share of the country's tax burden.

More than half say they want independence from Spain, the highest level ever.

Artur Mas, the conservative president of Catalonia, announced on Tuesday he would hold early elections in November after Rajoy rejected his call for more tax autonomy.

The vote, likely to be presented politically as a referendum for secession, is a challenge to Rajoy, who's People's Party has threatened to take central control over the budgets of regions like Catalonia that fail to meet deficit reduction targets.

Catalonia would face a number of constitutional hurdles to secede, and such an outcome is seen as unlikely any time soon.

Analysts say Mas is using the growing independence sentiment as a threat over Madrid to secure more fiscal autonomy.

"At a time when the PP could use the crisis to limit autonomy in the regions, Mas is engaged in a defensive move to try to shift things the other way," said Enric Juliana, Madrid bureau chief for Catalan newspaper La Vanguardia.

COMMUNICATION PROBLEMS

Anti-austerity groups planned a fresh demonstration on Wednesday evening in Madrid, a day after police fired rubber bullets at thousands of protesters who tried to form a human chain around the parliament building.

Police arrested 28 protesters on Tuesday and 64 police and demonstrators were injured in the clashes.

The relatively small but intense protests this week have added to Rajoy's image problems abroad.

Officials in Brussels and Berlin have accused him of failing to sell his reforms effectively, partly because of confusing messages from his separate treasury and economy ministers and from his own office.

"The problem in the structure of his economic cabinet is transmitting a confused, improvised image," said an economist, who did not want to be named and who said Rajoy will have to name a powerful economic deputy by the end of the year to sort out his communications issues.

The governments of Ireland, Portugal and Greece were all voted out of office after they sought bailouts from Europe.

But Rajoy may have more staying power, especially if he negotiates a bailout "lite", such as a precautionary credit line from the European bailout fund that would not involve taking Spain out of the credit markets.

The uncharismatic conservative has more than three years left to his term and his People's Party has firm control of parliament, with no signs so far of party splits that might force him out early.