Monday, April 26, 2010

The Eurozone's Fiscal Saga: Shifting Focus?

Since the Greek fiscal drama took center stage in January, the widespread expectation was that it would ultimately lead to the country's bailout, which would put out the intense flare ups of anxiety that were afflicting the sovereign debt markets. Although the moment of the all-but-inevitable bailout for Greece has arrived, it is now far from certain that the markets' apprehension toward European sovereign debt will subside any time soon.

As negotiations over the specifics of the fiscal austerity plan between the Eurozone/IMF and Greece continue, fears that the sheer magnitude of the country's total debt burden is unmanageable and will lead to a restructuring of its existing debt (over 300 billion euros), have intensified. It has also become increasingly likely that the initial amount earmarked for the bailout- a total of 45 billion by the Eurozone countries and the IMF- will prove to be insufficient and bound to increase.

The specter of a Greek default later this year will continue lurking in the background and become a source of variable anxiety for the Eurozone bond, as well as equity, markets. While a period of relative "calmness", in terms of headlines, may succeed the announcement of the Eurozone/IMF agreement with Greece in the coming days, attention is likely to quickly turn to the other two Eurozone countries that seem the most vulnerable after Greece: Portugal and Ireland.

Until now, the overwhelming urgency of Greece's predicament had essentially shielded those two countries from becoming the target of the global bond markets' wrath, although their borrowing costs have risen sharply since the beginning of the year. In relative terms, Ireland may be in a somewhat better position, given an aggressive fiscal austerity program it announced pre-emptively late last year and has been given the benefit of the doubt in terms of the country's commitment to implementing it so far. Portugal is in a more vulnerable state as its economy suffers from a structural lack of competitiveness- just like Greece's- and a debt burden that is almost 10% of GDP. To make matters worse, a set of measures to address these challenges that were announced a couple of months ago were viewed as of dubious effectiveness and the country's prospects for economic growth this year are particularly poor.

And all of this, without even considering complications with the fiscal picture in Spain and, conceivably, Italy at some point.

With the risk of a Greek default not disappearing convincingly any time soon and two other members of the PIIGS slowly coming under increasing scrutiny, the situation in the Eurozone is not likely to return to normal in the foreseeable future. What can also contribute to the tension surrounding the increased attention that some of these countries will now be receiving is the likely growing resistance by Germany and France -in that order- toward the prospect of engineering a series of additional Greek-style bailouts. Voices that have already been raised in Germany about ultimately forcing some of the weaker countries to leave the euro bloc may gain traction, and this is not exactly a dynamic that would make any questions about the future of the euro itself go away easily.

Anthony Karydakis