* 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
By Paul Day
MADRID, July 30 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.
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)