Spain’s heavily indebted eastern region of Valencia said on Friday it would need financial help from Madrid, spooking financial markets and complicating central government efforts to stave off a full-blown sovereign bailout.
On a tumultuous afternoon, the government also cut its economic forecast for next year, indicating the country would stay mired in recession well into next year after a contraction expected to be 1.5 percent this year.
Valencia, Spain’s most indebted region alongside its northern neighbor Catalonia, sought help under an 18 billion euro (US$22.1 billion) program passed on Thursday and aimed at helping the autonomous regions which, together with local authorities, account for about half of all public spending.
“Valencia, like other autonomous regions, is suffering the consequences of the liquidity shortage in markets due to the economic crisis,” the regional government said in a statement.
The program is funded by the Spanish Treasury, but the regions keep full responsibility over the debt.
The troubled regions, as well as a banking sector beset by a burst property bubble, have pushed Spain’s borrowing costs to -record highs and pushed the country closer to requiring a full-scale bailout.
Eurozone finance ministers approved the terms of a loan of up to 100 billion euros for Spain to recapitalize its banks on Friday. The exact size of the support will only be determined in September.
However, the Valencia announcement sent the risk premium on Spanish government debt to a euro-era high on Friday as its borrowing costs climbed to a record 7.29 percent, a level considered unsustainable, with little relief likely soon.
Despite its downgraded GDP forecasts, the government confirmed its deficit objectives for this year and next year, but did not release the details on how the efforts would be split between the regions and the central government this year.
It will use the new forecasts as a base to draw up next year’s budget, for which the ceiling has been set at 127 billion euros compared with 119 billion euros this year.
Spain’s regions, currently shut out of international debt markets, have been pushing for months for a financing mechanism to help them meet their financial obligations.
Deputy regional head Jose Ciscar who made public Valencia’s request, said it would now be in position to meet its financial obligations.
“This liquidity fund thus brings confidence,” he said.
Valencia, which already used several government credit lines in the first half of the year to meet debt repayments, still needs to repay 2.85 billion euros by the end of the year.
Spanish Minister of Finance and Public Administration Cristobal Montoro said after a weekly Cabinet meeting that the regional funding plan carried strict fiscal conditions that beneficiaries must meet while providing regular updates on its finances.
“The Valencian government will have an obligation to meet new conditions to gain access to this liquidity,” he said, after first showing his surprise when asked about the request.
Montoro also announced that the costs of funding the country’s debt were set to rise by 9.1 billion euros next year.
Spain, which on Thursday adopted most of the measures of a new package of spending cuts and tax hikes worth 65 billion euros, will next tap the markets on Tuesday when it sells three and six-month bills. It will also sell three to five-year bonds on Aug. 2.