Spain looked set last night to become the fourth eurozone state to seek a bailout from the European Union and the International Monetary Fund.
Reports were circulating that Madrid will make a request for external help to prop up the country's tottering banking sector as early as today, when eurozone finance ministers hold a conference call this afternoon. The Dutch Finance Minister, Jan Kees de Jager, said that such a momentous discussion could not be ruled out and also described the Spanish situation as "urgent".
However, the Spanish government denied that there are any imminent plans to request a bailout. The Deputy Prime Minister, Soraya Saenz de Santamaria, insisted that nothing would happen until a series of audits of the Spanish banking system have reported later this month. "Before taking any kind of decision one should at least have a first estimate of the figures" she told reporters in Madrid.
The European Commission, which would partly supervise a European bailout of Spanish banks, said Madrid had not asked for help, but also stressed that its resources were ready to be deployed if required. "If such a request were to be made, the instruments are there, ready to be used" said the Commission's economic affairs spokesman.
The German Chancellor, Angela Merkel, denied yesterday that her government was exerting any pressure on Spain to accept a bailout. She said: "It's down to the individual countries to turn to us. That has not happened so far, and [we] will not exert any pressure".
Yet, behind the scenes, European policymakers have spoken of the need for Spain to have a bailout agreement in place before Greece holds fresh elections on 17 June, which is likely to cause another outbreak of market panic if the anti-bailout parties strengthen their hand in Athens.
Barack Obama added his voice to those calling for prompt action in Europe yesterday. The US President warned that European leaders need to stabilise the continent's financial system and inject capital into weak banks "as soon as possible".
If Spain does request help, the money would come from either the temporary €440bn European Financial Stability Facility or the permanent €500bn European Stability Mechanism, which is expected to be introduced in July.
In a reflection of heightened market fears over Spain's solvency, 10-year borrowing costs crept upwards yesterday, rising to 6.24 per cent, a level widely regarded as unsustainable. There were also signs of pressure spilling over to Italy, the eurozone's next most vulnerable economy, where 10-year borrowing costs rose to 5.77 per cent. There was also evidence yesterday that the eurozone crisis is dragging down even Germany, the single currency's strongest economy. German exports fell by 1.7 per cent in April, a direct result of weak sales in the rest of Europe, where the country does 60 per cent of its trade.
The IMF will report on the size of the capital hole in Spain's banking sector on Monday. Reports have suggested that it will identify a shortfall of between €40bn and €90bn. The credit rating agency Fitch, which downgraded Spanish debt this week to BBB, has estimated that Spain's total bailout needs could be closer to €100bn.
The Spanish government has been resisting a national bailout because of the onerous conditions and regular inspections that have been attached to the EU/IMF rescues of Greece, Ireland and Portugal. Instead Madrid has been lobbying for the funds to be channelled directly to its banking sector. But this has met with resistance from senior German politicians who have insisted that only countries, rather than banks, can be bailed out by common European resources. Officials in Brussels have been attempting to broker a compromise, whereby the Spanish government would accept the money, but with minimal conditions attached.
The government of Mariano Rajoy has been fighting hard to slash the budget deficit, which stood at 8.9 per cent of GDP in 2011. In March, ministers set a target of reducing the deficit to 5.3 per cent of GDP by the end of 2012.
But Spain is expected to miss this goal, in large part because the economy is shrinking so fast. It is forecast by the European Commission to contract by 1.8 per cent this year.
The government is also under growing pressure from the street, where social discontent is rising. Unemployment has hit 24 per cent and joblessness among the young is above 50 per cent.
Spanish bailout: Key decision-makers
Mariano Rajoy, Spanish Prime Minister and leader of the centre right People's Party
An old political hand, having been the deputy of previous prime minister Jose Maria Aznar, he has put together a political team which is a blend of youth and financial experience.
Luis de Guindos, Economy minister
De Guindos was in Brussels this week for talks with the European Commission, and a former CEO of Lehman Brothers in Spain and Italy.
Economist Montoro has been put in charge of slashing Spain's 8.9 per cent budget deficit in her role as treasury minister. Also the loose cannon who admitted last week that the financial markets are "essentially shut" to Spain, inviting market panic.
Soraya Saenz de Santamaria, Deputy prime minister
The youngest member of the Madrid government, she is also said to be the one who wields the most power, short of Rajoy. She was working yesterday to play down reports of Spain requesting a bailout. Held talks with IMF chief Christine Lagarde in Washington at the end of last month - perhaps when the two sides began to put a deal together.
Rescue plans: The options on the table for madrid
The Spanish government wants to avoid receiving direct assistance in the way that Greece, Portugal and Ireland did. Rather, it would like Spanish banks to be directly recapitalised.
Limited bailout Under this option it is thought that a minimum of €40bn is needed to recapitalise the banks.
Full-scale bailout The beleaguered Bankia is thought to require at least €23bn alone and there are doubts that €40bn would be enough to assuage fears in the markets. Some analysts believe as much as €100bn could be needed.
No bailout The government could theoretically dismisses a bailout altogether, but that is looking increasingly unlikely.