Spanish stocks fell on Monday, with markets spooked by the prospect of a political stalemate following an early election in which the right-wing failed to win an expected victory.

Sunday's vote left neither the right nor the left with an easy path to forming a government, although the center-right Popular Party (PP) will be the first to try to muster enough votes in the Congress of Deputies.

The country's fiscal policy, banks and transition to green energy are in the spotlight and a prolonged political stalemate could dent Spanish stocks, which have risen more than 15% this year.

A Catalan independence leader on the run from Spanish justice could be the key to unblocking the situation, but that could also bring the Catalan independence debate back into the spotlight.

Here are five key questions for investors.

1/ HOW HAVE MARKETS REACTED?

Not very well. The Spanish Ibex index fell by as much as 1.8%, with the banking sub-index dropping by almost 3%.

The reaction of Spanish government bonds was moderate and the gap between Spanish and German 10-year yields was around 104.60 basis points.

Pablo Garcia, analyst at AlphaValue, said that there could be further declines in equities as markets are still waiting for the negotiations to result in a government agreement.

Garcia noted that "possibly the worst is yet to come." He added that foreign investors are a majority in the Spanish market and if none of the main candidates accept defeat, "that is very serious".

2/ WHAT DOES UNCERTAINTY MEAN FOR THE SPANISH ECONOMY?

The prospect of weeks of political wrangling casts a shadow over an economy that is slowing after a post-pandemic upturn. Monday's data showed that the slowdown in business activity in the eurozone deepened in July.

"It could delay or hinder the implementation of much-needed economic reforms and thus inhibit the long-term growth potential of the Spanish economy," said Wouter Thierie, an economist at ING.

However, Spain has proven resilient to short-term bouts of uncertainty in the past, he added.

The government forecasts economic growth of 2.1% in 2023, down from 5.5% last year. Spain's high debt levels are also under the spotlight, with debt exceeding 100% of GDP and a deficit of 4.8% of GDP.

3/ WHY DID ENERGY STOCKS FALL?

With Spain becoming drier and hotter, energy was one of the main election issues.

The PP is proposing to extend the life of nuclear power plants beyond their 2027-2035 closure window, which, according to RBC analysts, "would have been clearly positive" for electricity profits.

Now, "the potential near-term increase in profits will have to be eliminated," they said Monday.

"In addition, increased uncertainty will result in a higher cost of capital, at least until it becomes clear what form the new government will take."

This affected major energy companies. Endesa shares were down 3%.

4/ AND THE BANKS?

The shares of the main banks Santander, BBVA, Sabadell and Caixabank fell between 1% and 3%.

Investors had been watching the elections to see if the 4.8% levy approved in December on banks' net interest margins and commissions above 800 million euros (880 million dollars) would be extended.

Barclays said ahead of the vote that an inconclusive outcome might not be ideal for banks, "given that prolonged uncertainty would leave the tax issue unanswered and would generally be unfriendly to growth."

5/ ARE THERE IMPLICATIONS FOR THE EUROPEAN UNION?

Yes, because Spain has just taken over the six-month rotating presidency of the EU Council and legislation such as the new fiscal rules have to be approved.

Federico Santi, senior analyst for Europe at Eurasia Group, said the election results could be slightly positive for the EU.

He noted that senior leaders will be very distracted with government formation and a possible new election campaign, but it will allow some continuity and give diplomats the space they need to continue their work.

Spain wants to conclude a trade agreement with Mercosur, the South American bloc, and an EU-wide migration agreement. It also advocates a common corporate tax rate and progress in the EU banking union.

(1 U.S. dollar = 0.9072 euros)

(Reporting by Sam Indyk, Alun John and Dhara Ranasinghe in London, Jesús Aguado in Madrid and Matteo Allievi in Gdansk; compiled by Alun John; graphics by Kripa Jayaram, Pasit Kongkunakornkul, Sumanta Sen and Vineet Sachdev; edited in Spanish by Benjamín Mejías Valencia)