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Spain under scrutiny after ECB bond-buying plan

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MADRID — Investors and governments have applauded the European Central Bank's ambitious plan to ease Europe's financial crisis by buying unlimited amounts of government bonds.

The plan was devised to help out Italy and Spain, which are struggling with large debts and high borrowing costs.

After the bank's president, Mario Draghi, unveiled the plan Thursday, stock markets across the globe have rallied. More importantly, Spain and Italy have seen their borrowing costs fall.

But the ECB's offer of help is no gift. It requires countries that want help to first apply to the eurozone's bailout fund. That means agreeing to tough conditions — "strict and effective" adherence, as the ECB puts it, to cutting down on spending, deficits and debt.

So far, the leaders of Spain and Italy — trapped between pitiless markets and voters angry over austerity — have refused to commit to the latest scheme to bring an end to a crisis that has tormented Europe for the past three years and put a drag on global economic growth.

Here are key factors involved in the rescue plan:

—What would Spain and Italy need to do to get ECB help?

Draghi's plan involves potential purchases of unlimited amounts of a country's short-term government bonds, a step that would lower their borrowing costs. Buying government bonds in the open market would drive up bond prices and push down their interest rate, or yield. Then governments could take advantage of those lower costs the next time they borrow. They must constantly sell new bonds to pay off old bonds as those loan repayments fall due.

However, countries wanting central bank help must first ask the 17 countries that use the euro for an assistance program from the eurozone's existing bailout funds. The funds would have to join the ECB effort by buying bonds directly from those governments.

And they must submit their economic and budget policies to scrutiny by the International Monetary Fund.

Only then will the ECB step in — if it's satisfied the requirements are tough enough — and buy bonds with remaining maturities of one to three years on the open market.

— How is this different from previous bailouts?

The financial rescues of Greece, Ireland and Portugal meant lending them enough money so that they didn't have to go to international debt markets — which were charging unaffordable interest rates — to keep paying off maturing bonds.

Under Draghi's proposed remedy, the countries would continue to raise money from private investors. The ECB would act to ease the cost of borrowing.

That could end up annoying previous bailout recipients — who remain locked into painful debt-reduction strategies in return for the help.

— Why should Spain sign up to the ECB plan?

Spain is stuck in a double-dip recession and unemployment is close to 25 percent. Spanish Prime Minister Mariano Rajoy has already accepted an international loan of up to €100 billion ($127billion) to rescue banks reeling from a collapse in real estate values. But the government is struggling to pay punishingly high interest rates to raise money on bond markets and keep its economy functioning. The interest rate — or yield — Spain's 10-year bonds was 5.69 percent on Friday, while Germany's was 1.52 per cent. That wide gap may force Rajoy to take up Draghi's offer.

However, Rajoy may want to try and negotiate the terms of ECB intervention. And he has several factors in his favor. Spain has already raised three-quarters of all the money it needs so far this year. The mere announcement of the ECB plan has lowered its borrowing costs in the market. That means Spain can carry on a bit longer without outside help — while Rajoy holds out for easier conditions for an eventual rescue. His trump card: He knows his eurozone partners could not allow a catastrophic collapse of Spain's finances which would hurt them, too.

James Hughes, chief market analyst for London's Alpari UK, warns: "If he spends too long negotiating with the European creditors, the market will get frustrated and we'll quickly see yields move higher again."

Other European leaders may press Spain for an answer before an October 18-19 summit. The country will also need to borrow more money in late October to pay off bonds that are coming due.

Analysts at Nomura think Spain will hold off asking for help at an upcoming European finance ministers' meeting Sept. 14. This could trigger worry in financial markets. If bond yields rise again, "this should eventually push Spain into a bailout before the end October because of market pressure," they wrote.

— What is holding Rajoy back?

Rajoy is aware of the political downside of asking for help. He said for months Spain wouldn't need a financial lifeline. Now, however, he says he has made no decision.

"The Spanish are really proud. People always fail to understand that," said Gayle Allard, an economics professor at Madrid's IE Business School. But she noted that Rajoy is caught between political dishonor and economic infamy that is already tarnishing his government's record. "The (bond market) battering early this summer was bad enough that (Rajoy) might want to rescue his reputation," she said.

Rajoy is also wary of his voters. A recent €65 billion ($82.59 billion) package of tax hikes and spending cuts triggered widespread public protests. He has committed to maintaining pensions at their current level — but that promise might be hard to keep if Europe demands sharp deficit cuts.

Rajoy was elected in a landslide in late 2011 and has an absolute majority in Parliament, and isn't required to hold elections until late 2015.

"He's losing support but it's something he can afford now during his first year in office," Antonio Moreno, an economist at the University of Navarra, said.

—What about Italy?

Italy is in a slightly better shape than Spain and can afford to wait a little longer before accepting the ECB's conditions. Italian Prime Minister Mario Monti praised Draghi's plan as an "important step forward" but said any decisions on Italy's potential request for aid were "premature."

Nonetheless the country is struggling to manage its huge debt load — 120 percent of its economy. Plus its hand may be forced if Spain does apply for assistance. Barcelona-based economist Edward Hugh says if Spain enters the bond-purchasing program, but Italy decides to pass on the ECB's offer, Rome's yields could surge amid investor nervousness. "That could force them in," he said.


Barry Hatton in Lisbon, David McHugh in Frankfurt and Al Clendenning and Harold Heckle in Madrid contributed to this article.