* First Spanish region to seek rescue from central gov’t
* Spain’s recession to be prolonged until 2013
* EU gives go ahead 100 billion euros banking aid
* Spanish borrowing costs pushed to euro era highs
By Julien Toyer and Nigel Davies
MADRID, July 20 (Reuters) - Spain’s heavily indebted eastern region of Valencia said on Friday it would need financial help from Madrid, spooking financial markets and complicating central government efforts to stave off a full-blown sovereign bailout.
On a tumultuous afternoon, the government also cut its economic forecast for 2013, indicating the country would stay mired in recession well into next year after a contraction expected at 1.5 percent in 2012.
Valencia, Spain’s most indebted region alongside its northern neighbour Catalonia, sought help under an 18-billion-euros ($22.1 billion) programme passed on Thursday and aimed at helping the autonomous regions which, together with local authorities, account for around half of all public spending.
“Valencia, like in other autonomous regions, is suffering the consequences of the liquidity shortage in markets due to the economic crisis,” the regional government said in a statement.
The programme is funded by the Spanish Treasury but the regions keep full responsibility over the debt.
The troubled regions, as well as a banking sector beset by a burst property bubble, have pushed Spain’s borrowing costs to record highs and pushed the country closer to requiring a full-scale bailout.
Euro zone finance ministers approved the terms of a loan of up to 100 billion euros ($123 billion) for Spain to recapitalise its banks on Friday. The exact size of the support will only be determined in September.
But the Valencia announcement sent the risk premium on Spanish government debt to a euro-era high on Friday as its borrowing costs climbed to a record 7.29 percent, a level considered unsustainable, with little relief likely soon.
The euro fell as low as $1.2175, just above a two-year low of $1.2162 hit last week, while U.S. and European stocks also slid.
Despite its downgraded GDP forecasts the government confirmed its deficit objectives for 2012 and 2013 but did not release the details on how the efforts would be split between the regions and the central government this year.
It will use the new forecasts as a base to draw up the 2013 budget, for which the ceiling has been set at 127 billion euros compared to 119 billion euros in 2012.
Spain’s regions, currently shut out of international debt markets, have been pushing for months for a financing mechanism to help them meet their financial obligations.
Jose Ciscar, the deputy regional head who made public Valencia’s request, said it would now be in position to meet its financial obligations.
“This liquidity fund thus brings confidence,” he said.
Valencia, which already used several government credit lines in the first half of the year to meet debt repayments, still needs to repay 2.85 billion euros by the end of the year.
Treasury Minister Cristobal Montoro said after a weekly cabinet meeting that the regional funding plan carried strict fiscal conditions that beneficiaries must meet while providing regular updates on its finances.
“The Valencian government will have an obligation to meet new conditions to gain access to this liquidity,” he said, after first showing his surprise when asked about the request.
Montoro also announced that the costs of funding the country’s debt were set to rise by 9.1 billion euros in 2013.
Spain, which on Thursday adopted most of the measures of a new package of spending cuts and tax hikes worth 65 billion euros, will next tap the markets next Tuesday when it sells three- and six-month bills. It will also sell three- to five-year bonds on Aug. 2.
Several Spanish regions - some of them governed by the ruling People’s Party - have rebelled against the latest cuts.
Catalonia, the Basques and Andalucia have also said they would not implement all the cuts because it would end up killing the public education and health systems they control.
Analysts believe most of the autonomous regions will miss their deficit target of 1.5 percent of the economic output this year.
The government last week asked at least eight of the 17 to revise their budget plans for 2012 to meet tough deficit goals and is now threatening a handful of them to take over their finances.
There are signs of growing discontent at the economic pain being heaped on the Spanish public. Hundreds of thousands of Spaniards marched against the centre-right government’s latest measures on Thursday evening, following more than a week of demonstrations across the country.
Spain has raised 69 percent of its original medium- and long-term debt target of 85 billion euros for the year.
But the new deficit goals and the burden from the regions is expected to increase it by around 20 billion euros, putting more pressure on the country’s credit rating which is already just one step away from junk territory.