Euro Zone Bailout Fund May Grow to €700B As Spanish Debt Rises

The euro zone may increase its bailout funds to almost €700 billion ($914.6 billion) as the sovereign debt of Spain, the monetary union's fourth largest economy, soars to a 17-year high and exposes the continent's finances to a potential catastrophe.

The temporary European Financial Stability Facility (EFSF) and the permanent European Stability Mechanism (ESM) have a maximum, combined lending level of €500 billion, Reuters said Friday. While several options are under discussion, a senior euro zone official said, one possibility is the combined lending capacity would go from 500 billion to 692 billion, roughly 700 billion. That would represent an increase of about 40 percent.

Without such an increase, the bond market could drive up Spain's borrowing costs to unsustainable levels, threatening the euro zone with a sovereign debt crisis vastly more acute than Greece's sovereign debt crisis.

Euro zone finance officials and central bankers will meet in Copenhagen on March 30-31 to discuss the size of the two bailout funds. Markets have sought larger bailout funds, but any increase in funds has been opposed by Germany.

German Chancellor Angela Merkel, however, left a little wiggle room on the size of the bailout funds in the runup to the meeting at the end of the month. Merkel said a decision on increasing the bailout funds would be made before an International Monetary Fund meeting in April, Bloomberg News reported, but she also said there was no option for expanding the permanent ESM above its €500 billion limit.

That may not, however, preclude a temporary expansion of the lending capacity of the EFSF.

Talk of strengthening the bailout fund comes as Spain's national debt rose in the fourth quarter to 68.5 percent of its gross domestic product, a 2.5 percentage point increase over the third quarter, and 7.3 percentage point increase since the same time in 2010.

Besides the government's cumulative debt, its annual budget remains dangerously in the red. Last year, the Spanish government had an annual budget deficit of 8.5 percent of GDP, a decrease from 2010's 9.2 percent, but still well above the target of six percent, reported the Wall Street Journal. The government will attempt to trim its budget deficit even more this year, to 5.3 percent of GDP, but it will be difficult with Spain's economy projected to contract 1.7 percent during the year.

Some analysts predict Spain, encouraged by Greece's default last week, may be heading in the same direction, making a robust bailout fund even more of a necessity for the euro zone than it was to save Greece from declaring bankruptcy.

While Spain's debt of 68.5 percent is low compared to the euro zone average of 87.4 percent, it is increasing more quickly as unemployment has surged to 23 percent, the Wall Street Journal reported. Spain's debt has steadily grown since a low of 36.2 percent of GDP in 2007.