CORRECTED-UPDATE 2-Spain's economy close to levelling off but beset by risks

Tue Jul 30, 2013 7:36am EDT

* GDP shrinks 0.1 percent in second quarter, as expected

* Reliance on growth abroad suggests uphill recovery

* High jobless rate, illegal payment scandal also weigh

* Santander results show weakness in Spain, flicker of hope for property sector (Corrects spelling of analyst Ebrahim Rahbari in fourth paragraph)

By Paul Day

MADRID, July 30 (Reuters) - Spain's economy all but emerged from a two-year slump in the second quarter but its recovery looks fragile at best, given weak consumer demand and a simmering political scandal at home and faltering growth abroad.

Gross domestic product shrank 0.1 percent between April and June from the previous quarter, according to Tuesday's data from state statistics agency INE, which matched a Bank of Spain estimate given last week as well as market forecasts.

Between January and March the economy shrank 0.5 percent.

Given the signs of an upturn in economic activity, also including the first drop in unemployment in two years in the second quarter, Economy Minister Luis de Guindos has called an end to Spain's recession.

Many economists are not convinced.

"We're not counting on a further improvement in the third quarter and are very sceptical of any statement that the recession in close to being over," Ebrahim Rahbari, an analyst at Citi in London, said.

Spain's economy has been in and out of recession since 2008, when a burst property bubble undermined the foundations of one of the country's key pillars of growth, construction.

That sent unemployment to record highs, depressing business and saddling the banking system with billions of euros of soured real estate assets and loans.

Spain's biggest bank Santander SA, which insulated itself against the worst of the market meltdown by expanding its already dominant foreign operations, said on Tuesday half year group profits rose 29 percent on lower loan losses.

It said operating earnings were hit by the sluggish Spanish economy but also offered hope the impact of the property slump on the government and lenders - bailed out last year with 42 billion euros of European aid - might be easing.

It said provisions against loan losses - which many Spanish banks booked heavily in 2012 - dropped sharply, and that it might consider buying nationalised banks Catalunya Banc or NCG Banco if they came up for sale.

TEMPORARY RESPITE

Since 2008, already subdued domestic demand has been knocked back further by tax hikes and spending cuts aimed at balancing a budget which has one of the largest shortfalls in the euro zone.

Growth-friendlier policies have played a bigger role in Europe's economic debate in recent months as austerity has lost its lustre, but Spain's still high fiscal imbalances mean more budget cuts will have to be made, potentially hitting the tentative signs of recovery.

Meanwhile, allegations of millions of euros being filtered illegally to ruling party leaders, including Prime Minister Mariano Rajoy, has helped half the conservatives' approval rating putting them level with the opposition Socialists.

That has added an element of political instability that carries faint, but nonetheless unwelcome, echoes of events in fellow euro zone struggler Italy, where a shaky coalition government could fall if former prime minister Silvio Berlusconi loses a supreme court appeal hearing that began on Tuesday.

But the centre-right People's Party of Rajoy, who has denied wrongdoing, has a strong majority in parliament and unless new evidence ties him directly to the scandal, he is expected to remain in power.

Rajoy, along with his economy minister, has recently done his best to talk up the economy, and the second quarter also saw the first drop in unemployment in two years, to 26.3 percent,

But that lower figure - still more than double the euro zone average - was largely due to temporary factors especially strong trade data, which includes seasonal tourism.

Spanish retail sales due on Wednesday are expected to show high-street spending has shrunk every month for three years.

Spain's high reliance on activity beyond its borders - exports rose to a third of economic activity in the first quarter - adds uncertainty to the outlook amid a shaky global recovery and enduring weakness in Europe, where around 70 percent of Spain's exports are sold.

Martin van Vliet, analyst at ING, said he expected Spain's economy to flatline and then gradually return to growth in the first half of next year. "But the pace of growth will probably be too slow to create jobs, which is a prerequisite to embark on a self-sustaining recovery," he said. (Editing by Fiona Ortiz, John Stonestreet)

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