Spanish economy in huge crisis after credit downgrade

Spain's unemployment rate shot up to 24 percent in the first quarter, the highest level since the early 1990s and one of the worst jobless figures in the world. Retail sales slumped for the twenty-first consecutive month.

The figures are terrible for everyone and terrible for the government ... Spain is in a crisis of huge proportions, Foreign Minister Jose Manuel Garcia-Margallo said in a radio interview.

Standard and Poor's cited risks of an increase in bad loans at Spanish banks and called on Europe to take action to encourage growth.

Bank shares dropped 3.38 percent and Spain's country risk, as measured by the spread on yields between Spanish and German benchmark government bonds, spiked by 10 basis points to 434 basis points.

Spain has slipped into its second recession in three years putting it back in the centre of the euro zone debt crisis storm.

The government has already rescued a number of banks that were too exposed to a decade-long construction boom that crashed in 2008, and investors fear vulnerable lenders will be hit by another wave of loan defaults due to the slowing economy.

With the economy shrinking, Spain has little hope of meeting tough public deficit targets this year even as the government makes tough cuts.

Conservative Prime Minister Mariano Rajoy, in office since December, has passed an austerity budget and introduced new laws to try to make the economy more competitive.

On Thursday Rajoy said he was determined to stick to austerity measures even though they are aggravating the economic slump and calls for growth measures are on the increase around Europe.

The unemployment rate was up from 22.9 percent in the last quarter of 2011. Half of Spain's youth is out of work, and figures are unlikely to improve for some time as government spending cuts this year worth around 42 billion euros hold back any potential for growth.

The government expects labor reforms passed in the first quarter that make it cheaper for firms to hire and fire to produce results next year. Many firms have taken advantage of new rules to lay off more staff.

It's a very challenging situation. I don't think that the banks are cornered yet, but the government must come out soon to say how they will address them, said Gilles Moec, an economist with Deutsche Bank.

The downgrade put Spain's credit rating at the same level as Italy. S&P now has Spain on a BBB+ rating, which means adequate payment capacity and is only a few notches above a junk rating. Fitch and Moody's still rate Spain's sovereign with a strong payment capacity.

S&P  said it was likely the government would have to put more funds into banks and called on euro zone countries to better manage the sovereign debt crisis.

The government is considering whether to create a holding company for the banks' toxic real estate assets as investors have not been convinced by three rounds of clean-ups and consolidations in the financial sector.

(Additional reporting by Sonya Dowsett and Inmaculada Sanz; Writing by Fiona Ortiz; Editing by Giles Elgood)