Spain is in a crisis "of huge proportions", the foreign minister, José Manuel García-Margallo, has said after official figures showed unemployment had hit almost 25% amid concerns that the country's banking sector may need a €120bn (£98bn) bailout before the end of the year.
The jobless rate stood at an 18-year high after the latest figures showed it at 24.4%, or 5.6 million people out of work. Unemployment is now the focus of debate in the country as policymakers worry about the effects of a collapse in consumer spending, a drop in tax receipts and spiralling bad debts.
Standard & Poor's, the ratings agency that downgraded Spain's credit status on Thursday, said it was concerned the situation was worsening and rising defaults on loans and mortgages could quickly undermine the banking sector.
Critics of the rightwing administration headed by Mariano Rajoy said government policies were partly to blame for making the situation worse. The rate has soared on the back of labour reforms that make it easier and cheaper to sack people. Some 374,300 jobs were lost in the first three months of this year, representing an estimated loss of €953m in income tax receipts.
An austerity budget passed last month which pushed up education and health charges while cutting benefit payouts is also blamed for undermining household incomes and prolonging the recession.
On Friday the economy minister, Luis de Guindos, said VAT and other indirect taxes would have to rise next year to raise a further €8bn.
In four of the country's autonomous regions the jobless rate is over 30% and across the country 52% of under-25s are out of work, leaving 1.72m households without a single member in work.
Engracia Hidalgo, the employment minister, said there were "no positive indicators," while García-Margallo described the figures as "terrible for everyone and terrible for the government". Of Spain's 47 million inhabitants, only 17,433,200 are in work.
In a radio interview, García-Margallo urged the EU to do more to promote growth. "What's bad for us is bad for them," he said. "It's like the Titanic – if it sinks, the first-class passengers go down with it." He defended government reforms, saying there was no alternative. "When you take strong measures to treat a sick person, at first they become weaker, but if you don't apply this treatment they won't get better," he said. However, austerity alone was not enough, he added.
Spanish banks have long been suspected of disguising billions of euros of bad debts on their books after a property price collapse wiped more than 60% off the value of homes in some areas. Many families have maintained mortgage payments during the crisis, but a steep rise in unemployment has sent the number of bad loans soaring.
The government is considering whether to create a holding company for the banks' toxic real-estate assets after three rounds of forced clean-ups and consolidations in the financial sector failed to draw a line under the problem.
S&P, which downgraded the country's rating from A to BBB+, said: "It is not going to be an easy job for most Spanish banks to find funding in the market. So the state may be called for at some point. But that, for now at least, is something the Spanish government seems to be unwilling to contemplate."
The chaotic situation caused further falls on the Madrid stock exchange and interest rates on 10-year sovereign bonds touched 6%. S&P expects the Spanish economy to shrink by 1.5% this year and 0.5% in 2013. The agency does not expect the creation of new jobs in Spain before 2015. Fernando Jiménez Latorre, the secretary of state for the economy, said he did not expect unemployment to rise above 25% this year. He complained that S&P had not taken into account all of the adjustments the government had made, such as capping the budgets of the regional governments. Its analysis was "short term" he said.
Alfredo Pastor, an economist at the IESE business school in Madrid, said: "In the big numbers, we are not going to see the effects of the labour market reform before 2013. In fact, Spain needs deeper reforms that are effective and productivity enhancing. In the current recession, as well as labour reform, the government needs to take other measures, such as helping credit flow to business in order to help create jobs."
In his blog for the financial daily Expansión, Ismail de la Cruz asks: "How much longer can this state of affairs last? Not much. We can't discount the likelihood that the Spanish banking sector will need external help from Europe before the end of the year. The problem is that Spain is not capable of doing this with its own resources and it's hard to find foreign investors who are prepared to take the risk. Which leaves no option but a European rescue fund."