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By Andrés González
MADRID (Reuters) - Spanish Prime Minister Mariano Rajoy apologized on Thursday for mishandling a major corruption scandal, but denied he or his center-right People's Party accepted illegal payments and rejected opposition calls to step down.
It was the first time Rajoy had admitted any error since it emerged in January that the ruling party's former treasurer Luis Barcenas - in jail pending trial on charges of bribery and tax evasion - hid up to 48 million euros in Swiss bank accounts.
"I was wrong. I'm sorry but that is how it was. I was wrong in trusting someone we now know didn't deserve it," Rajoy told parliament at the start of a 5-1/2-hour special debate on the funding scandal that was carried live on television.
In a defiant one-hour speech and two shorter rounds of debate, he made no other admission of wrongdoing.
But he acknowledged the scandal has damaged Spain's image abroad at a time when his government is wrestling with a shrinking economy, 26 percent unemployment and a big budget gap.
Investors have shrugged off the scandal as it has not destabilized the government and on Thursday Spain sold debt more cheaply than two weeks ago. A European Central Bank back-stop for ailing euro zone countries has held Spain's borrowing costs at a reasonable level after they jumped last year and ignited fears of an international bailout.
Barcenas, who left his post in 2009 but continued receiving financial support from the party, told a judge he collected millions in cash donations from construction magnates and distributed them to senior PP figures, including Rajoy.
The Spanish leader has been criticized for maintaining contact with Barcenas up until recently. In January the prime minister sent the former treasurer an SMS text message that read: "Luis. I understand. Be strong. I'll call you tomorrow."
During the debate, opposition leaders from the Socialist and other parties repeated demands that Rajoy quit.
"Any other leader of a serious democracy in Europe would have stepped down over the SMS messages that you found perfectly acceptable. Can you imagine (German Chancellor Angela) Merkel texting a tax evader to tell him to 'be strong,?" asked Socialist leader Alfredo Perez Rubalcaba.
However, Rajoy said he would stay in office and continue with economic measures which have included spending cuts, tax hikes and rules to make hiring and firing less costly, policies welcomed by investors and Spain's European partners.
For months Rajoy had avoided any detailed statement on the Barcenas scandal. But as public pressure for accountability has grown and opposition parties threatened to call a vote of no confidence, Rajoy agreed to testify before lawmakers.
Rajoy said he had always declared all his income to tax authorities and said a judicial investigation would prove that there was no illegal financing in the party.
Barcenas, who worked 30 years for the PP, has testified that he maintained for almost two decades a set of shadow accounts tracking a slush fund of cash donations and payments that were hidden from tax authorities and auditors.
Rajoy dismissed the allegations as "a surprising and imaginative collection of lies" and said his party would be vindicated by the official investigation.
He said party members received payments beyond their salaries, for expenses and for seniority premiums, but said all those items were officially registered and that it was up to each individual to declare them in tax statements.
"The judge will determine how to proceed with each insinuation but I can tell you now that there was no shadow accounting and no crime was covered up," he said.
The scandal has damaged Rajoy's credibility and eroded voter support for the PP. But with the prime minister expected to hold on to power due to his party's strong majority in parliament, investors have barely reacted.
"There was some market concern about a month ago that Rajoy would be forced to resign but since then he's said he would carry out the full term, so no one's really paying attention to it," said Bhavisha Patel, strategist at consultancy 4Cast.
Opinion polls show politicians and political parties are widely mistrusted and the Socialists and the PP have lost significant ground to smaller parties which are perceived to be more honest.
(Writing by Fiona Ortiz; Editing by Gareth Jones)