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Mr Rajoy's problem is that Spain has a mountain of debt to raise next year. It will likely need to issue €124 billion of bonds and bills next year, according to UBS estimates. And it must raise this money against a backdrop of a deepening recession, with most forecasters expecting Madrid to miss its 6.3 per cent of GDP deficit target, and rising political instability reflected in regional tensions.
To have any hope of raising this money, Mr Rajoy needs to lure back foreign investors, who until last month had been reducing their holdings of Spanish bonds. Madrid faces major bond redemptions in January and April. Some argue the OMT is essential to reassure investors. But what will really decide Spain's fate is whether Mr Rajoy can convince the market he has truly cleared up the country's banking mess.
That remains an open question. Mr Rajoy's previous failed reform efforts have left his government woefully short of credibility. Madrid insists the latest stress test, which identified a €54 billion capital shortfall, was fully independent since it was led by external consultants and overseen by the ECB, the European Banking Authority and the International Monetary Fund. But even if one accepts this—and some analysts remain critical of key assumptions —the clean-up still does not look sufficiently thorough.
Ideally, a bank crisis resolution would remove all the bad assets from the system and not just from nationalised banks; failed banks should be shut down, leaving behind only those institutions with viable business models. But the "cleaned-up" Spanish banking system will still have external debts of €892 billion, equivalent to 83 per cent of GDP, a loan to deposit ratio of close to 150 per cent and will still be reliant on the ECB for funding equivalent to 35 per cent of GDP. At the same time, much of the system is weighed down by legacy mortgages with an interest rate well below the rate that banks currently pay for deposits and bond market funding.
Even after the recapitalisation, the bulk of the bad debts will remain on bank balance sheets and banks will still be reliant on the ECB. If Madrid is also counting on domestic banks to continue to buy its bonds, the toxic link between sovereign and banks won't be broken but reinforced.
Of course, Mr Rajoy's gamble may pay off. Perhaps a comprehensive Greek debt deal in the coming days, plus decisive action by the eurozone before the year end towards the creation of its banking union, plus a fair wind from the global economy will ride to Spain's rescue. But senior Spanish bank executives privately believe the OMT is essential to get their funding costs down to a level where the banking system can be restored to health.
And if the bank reform plan turns out to have been half-baked, then Mr Rajoy may find not even the OMT is enough to persuade markets to keep funding his government.