There are many similarities with the problems of fellow Euro member - Greece. But, there are differences.
source: Spain's problem P.Krugman
The Spanish economy has become increasingly uncompetitive. Wages have risen faster than other countries leading to a decline in relative productivity. This has led to a decline in demand and rising unemployment. Again, like Greece, Spain has no ability to devalue to regain competitiveness.
Boom and Bust
Spain had a spectacular boom - focused on housing and construction. This led to a rise in house prices and a rise in house building. Though Spain avoided the irresponsible subprime mortgage markets (in fact Spanish bank - Santander has made great strides in capturing market share in the UK), the rise in Spanish house prices was punctured, leading to a large fall in prices. Unlike the UK, Spain has now a large stock of surplus houses that nobody wants. This excess supply will depress house prices for much longer than in the UK.
The fall in house prices and decline in construction industry has had a big impact on GDP and jobs. The construction industry was a key factor in the Spanish economy but is now struggling, leading to a high number of job losses. Some 900,000 of the new unemployed are largely unskilled construction workers.(2)
Spain has had a persistent long term unemployment problem. This has only been exacerbated by the recession and boom and bust. In Dec 2009, Unemployment was just below 19%. This places a huge strain on government finances, but, more importantly is a real social and personal loss for those (mostly young people) who find themselves unemployed.
The problem is there seems little immediate hope of a change in fortunes. Whilst the economy is uncompetitive, there is no obvious source of growth and development.
Prospect of Deflation
CPI inflation in Dec 2009 was 0.9%. But, the deflationary forces in Spain - the prospect of wage cuts, fiscal tightening and a continued fall in house prices could create deflation (a fall in prices). Deflation would further depress the economy and make the economy struggle to recover from this bust.
Rise in Government Borrowing
Spain has a reasonably good set of public finances - public sector debt is currently 59.5% of GDP (2009 est.) - though this is a sharp deterioration on 2008 when gross debt was 40.7% of GDP (1). Spain has gone from budget surplus in 2007 to a deficit of over 10% of GDP last year (2). The recession has caused a large rise in government borrowing. Total debt is not too high, but, the rapid deterioration causes an additional headache. The fiscal tightening will at best do nothing to help the economy recover.