Editor’s note: Just when everyone had thought the worst of the eurozone troubles might have passed, they returned with concerns about the debt plight of Spain. Here, the UK wealth management firm Evercore, the business whose founders include former government minister John Redwood, examines the latest developments. As always, this publication stresses that it does not necessarily share the views of such contributions but is grateful for its addition to the debate.

In recent weeks markets have become more concerned about Spanish finances than Italian ones and the news last week that Spanish debt has been downgraded by credit ratings agency S&P brings more speculation of a deepening crisis. Spanish electors have played their part and voted in a new government even more committed to the austerity policies of Euroland than the outgoing one. The new government willingly signed up to the new Treaty of the 25 to enforce more austerity and budget discipline on themselves. Then things started to go wrong.

The government confessed that there had been slippage last year under their predecessors. The 2011 budget deficit turned out to be as high as 8.5 per cent. Worse still, the new government said they could not hit the tough targets for 2012. After discussions they ended up with a revised target of 5.3 per cent of gross domestic product for extra borrowing.

Just to hit this target they had to announce a more austere austerity budget with additional tax rises and spending cuts last week to try to reassure markets that they would keep to these new estimates. There were cuts in spending. The main cross government items were a further wage freeze for civil servants, and a ban on external recruitment. There were tax rises, including confirmation of a very unpopular property tax. There were more promises to clamp down on avoidance. They will offer an amnesty and a light tax rate to people who want to regularise their affairs. They are out to close various legal loopholes that companies have been using. The billing of the budget as the most austere ever probably outran the reality, but the direction of travel is clear for all to see.

So are the problems. Some in the markets worry that the tax rises on the private sector combined with the spending cuts for the public reduce demand and output further, which in turn means downwards pressure on tax revenues and upwards pressure on benefit budgets for the unemployed. With 23 per cent out of work and almost one half of all young people without a job, these are tough times for Spaniards. If the economic output falls more than expected, or continues to disappoint in later years, the government will not hit its estimates of revenue and may have to spend more.

There is also the problem of the Spanish banks. They are nursing various loans against land, buildings and construction projects that have been damaged by the savage downturn in these areas. The government wants the banks to make more provision against future losses, and has asked the banks to come up with another €52 billion this year in extra provisions and capital to make the position more secure. If the state is dragged into supporting the banks more, that will weaken state finances more as well. The state of the banks will limit new credit for new projects, making fast recovery that much more difficult to achieve.

The EU forecasts a 1 per cent fall in Spanish output this year, and the IMF a 1.7 per cent decline; S&P now agrees, revising its previous forecast of 0.3 per cent to a 1.5 per cent decline. We will keep the Spanish 10 year bond yield on our watch list. The combination of a past property crash, some weak banks, euro membership and stretched state finances is a worrying mix. There could be another phase to the Euro crisis where markets show more concern about the pain in Spain.

The rolling Euro crisis contains a couple of dangerous ingredients. Firstly, there is that toxic combination of weak banks propped up by a weak state, which in turn needs to borrow from those self same banks.  Spanish state finances are stretched, though better than Greece or Portugal. If the banks need substantial new capital to repair loan losses on construction and property, that will be difficult for the state to find. In the meantime, the need to rebuild bank balance sheets is restricting credit growth and general growth. The lack of competitiveness amongst the weaker economies adds to the tensions. Spain had too much inflation relative to Germany in the first years of Euro membership. It has left her struggling to find work for people and to balance her economy.

So far Spain has been able to finance her state deficit and her weak banks without needing special loans from the EU and IMF. Whilst Greece, Portugal and Ireland have been forced to seek subsidised borrowings and submit to an IMF programme, Spain has been able to manage her own affairs in the bond markets. It is generally thought that a Euro country can just about afford borrowing under 7 per cent for 10 years, though 6-7 per cent is getting dear. Spain’s ten year rate has been drifting up, and after last week's news pushed over 6 per cent.

So far this year the Spanish government has been able to raise all it needs to borrow, and is a little ahead of its programme, but most of the money raised recently have been short-term loans. This means it will need doing again all too soon. The significant thing is that recently Spanish borrowing costs more than Italian, reversing the position of last year when Italy seemed more at risk. The government has to do more to reassure markets that deficit reduction targets will be hit and the economy will be able to grow again. Otherwise the bond markets could prove difficult to manage.