ANALYSIS-Spain debt to struggle in 2010 after easy ride

* Spain debt spread seen overvalued in a liquid market

* Further ratings pressure expected later in 2010

* Fundamentals increasingly important, say economists

By Paul Day

MADRID, Jan 21 (Reuters) - Spain's government is likely to face problems funding its ballooning fiscal deficit once the European Central Bank shuts off its abundant liquidity flow and massive domestic unemployment thwarts efforts to cut spending.

While no one thinks Spain will become the next Greece -- seen by some investors facing potential default -- risk premiums will push higher unless the government makes a more convincing case that is prepared to slash budgets at a time when the economy is still in the casualty ward.

"Spanish debt is going to have to settle for an unfavourable valuation by the end of the year. Spain is the ugly sister of the euro zone this year. It'll be invited to the ball, but it's going to have to work so much harder than everyone else to get noticed," said economist at 4Cast Jose Garcia Zarate.

The world's central banks launched a range of policies to combat the global financial crisis, such as providing unlimited liquidity to banks and even buying bonds outright like in Britain, boosting sovereign debt markets across the world.

Spain jumped on the opportunity to finance one of the world's largest stimulus plans in relative terms, with sovereign debt traders boasting large, liquid portfolios and Spanish banks -- the biggest buyers of bonos -- eager customers.

At the moment, Spanish 10-year bonos trade at a spread of about 89 basis points over benchmark German bunds, in line with Italy at 86 but far below the 291 basis points demanded of euro zone pariah Greece.

However, in three years a fiscal surplus had been turned in to a deficit expected to top 10 percent of gross domestic product in 2009 and 2010.

With unemployment the highest in the euro zone at almost 20 percent, the Spanish government isn't expected to make the deeply unpopular spending cuts needed to bring the deficit under control.

Once the ECB reins in its crisis measures this year and liquidity becomes scarce, markets will grow more discerning and Spain's fundamental economic woes will be more of an issue on trading floors.

RATINGS PRESSURES

Some economists fear Spain is facing a runaway debt situation as its annual gross public debt issuance rose from around 20 billion euros just a few years ago to above 100 billion euros in 2009 and this year.

"What we are looking for is signs the government is setting out a strong medium-term plan on how they're bringing down the deficit and stabilising the public debt from 2011 onwards in the next three to four years," said Brian Coulton, economist at Fitch credit ratings agency.

Fitch, like rival Moody's, awards Spanish sovereign debt its highest possible rating.

Standard & Poor's has been more bearish, cutting Spanish debt a year ago to AA+ from AAA and revising its credit outlook to negative in December.

The government says it is committed to bringing down its deficit to 3 percent of GDP by 2013, in line with European Union guidelines.

The Socialist government has already announced stimulus spending cuts and a two-percentage point increase in value-added tax, and says it will announce further austerity measures at the end of January.

But economists are sceptical they will meet their target.

"I can't really see Spain delivering the kind of consolidation required to put its credit rating on a more stable footing. A further rating downgrade is quite likely," said interest rate strategist at Citigroup Steve Mansell.

Abundant liquidity in the market has kept spreads low, Mansell said, and added he believed fair value for Spanish 10-year debt was between 100-120 basis points over Germany.

The agencies agreed the timetable to bring down the deficit was unrealistic.

"They may not make it by 2013," said Anthony Thomas from ratings agency Moody's, although he thought they might scrape in by 2014.

"In many ways the budget toward the end of this year is going to be very important for the rating," Thomas said.

S&P's view was more stark.

"If the government announces concrete fiscal measures that we believe could credibly achieve annual primary surpluses of around 2 percent or higher over the medium term, downward pressure on the rating may abate," said S&P economist Trevor Cullinan.

(Reporting by Paul Day; Editing by Toby Chopra)