Saturday, 2 October 2010


On 30 September 2010, one day after the strikes and demonstrations across Europe with Brussels at the center, Moody’s Investor Service downgraded Spain’s debt, making it more difficult and costly for the government to borrow. The IMF immediately joined EU to criticize S & P, Fitch and Moody’s for the damage they have inflicted on government financial stability ever since the Greek crisis erupted.
On the same day, the Irish Central Bank announced that an additional 14 billion euros ($19 billion) will be needed to save the Irish banks, bringing the total bill to 50 billion euros ($68 billion at current exchange rate). This at a time that the Irish economy contracted by 1.2% instead of growing by 0.4% as had been expected. The IMF immediately cautioned investors not to draw comparisons between Ireland and Greece, but Ireland was the first EU country to help its banks, yet, it remains at the heart of financial/economic trouble among the PIIGS (Portugal, Ireland, Italy, Greece and Spain). As a result of a budget stalemate in Portugal, bond yields are the highest in 13 years and the center-left government of Jose Socrates introduced higher indirect taxes, pay cuts for public employees, a freeze in public investment and it is about to launch Greek-style austerity measures to achieve fiscal discipline. Like Greece and all the other debtor countries in Europe, Portugal found itself under immense pressure from the EU to undertake austerity measures. On 1 October 2010, the European Commission decided to focus on Ireland, Portugal and Spain in order to contain the damage, primarily by announcing that EU approves of their policies. Italy is also in trouble despite Berlusconi presenting rosy scenarios, as it is projecting lower GDP growth for next year and higher debt. Berlusconi, however, has just received a vote of confidence, thereby postponing the inevitable political instability that would have necessarily translated into further financial and economic instability. Eastern Europe and the Balkans on the periphery of the EU, more as dependencies than equal partners to northwest Europe, are feeling the squeeze of the global crisis, as they are tightening budgets and experiencing economic contraction. At the center of the EU financial and economic troubles remains Greece as the poster child of debtor nations that manages to combine endemic public and private sector corruption, and all this with a Socialist regime that is more neo-liberal and pro-free enterprise as the IMF would have it than any conservative government in Europe. While Greece has managed to avoid default for now, there is the fundamental question of how and if it will be able to service a debt that amounted to 113% of GDP in 2009, rising to 150% of GDP by 2014 during which years the economy is expected to contract. In the absence of default of some rescue plan that involves another EU-IMF bailout package, how will the Greek government be able to find an additional 67 billion euros on top of existing obligations to service the debt after 2015? The government is hoping to avoid default by following the IMF-EU austerity measures. Yet, it is off its target to reduce the deficit because revenue is off by 13% owing to the fact that the economy is shrinking at about 4% and unlikely to grow given that unemployment hovering around 10% will probably rise by at least another 5% in 2011. The government is slashing the reputedly unproductive public sector which will result in higher unemployment and increased poverty, currently at 20%. The result will be lower fiscal revenues and lower private consumption. Greek government is counting on foreign investment to stimulate growth and it has struck some deals with Arab countries and China. However, foreign investment is hard to come by these days of financial retrenchment, and besides, neighboring Turkey along with Eastern Europe and every Balkan country is competing to attract foreign investment and in many cases they are offering more attractive terms than Greece. The Greek government is counting on integrating a portion of the underground economy into the mainstream so that it contributes to the fiscal system. Integration of the “informal economy” into the mainstream is a long-term proposition and unlikely to succeed to the level the authorities are hoping. Meanwhile, every day more and more small businesses are closing, largely owing to the economic contraction which favors large enterprises. At the same time, banks are approving one to two out of ten loan applications, as business growth, especially construction, have come to a standstill. The Greek government is counting on the EU for help. There are a number of analysts that expect Greece to default within the next two years or so, and that would mean at least a 10% drop in the euro, and a scramble by the EU commission to prevent a domino effect from taking place, that is, Portugal, Ireland, and Spain defaulting as well. My own view is that much will depend on the GDP growth of the core (creditor) economies and it is early to predict default, though some type of restructuring may have to take place. Meanwhile, the European Commission is becoming tougher with debtor countries and proposing: a) members must not exceed the 3% budgetary deficit as % of GDP debt limit; b) public spending cannot exceed GDP growth; sanctions against members that surpass the EU’s debt ceiling of 60% of GDP; c) chronic violators would pay penalty of 0.1% of GDP. The EU/IMF Rescue Plan, capitalized at one trillion dollars, is intended not to protect the weaker states like Greece, but the euro as a reserve currency and the stronger members as creditors. As I have written in previous postings for WAIS, the EU creditor nations are determined to create a two-tiered union, especially now that it is expanding and Eastern Europe is integrated or about to join full membership. The German concept of integration is based on a patron-client model where the core remains strong within the bloc in order to compete with other regional bloc dominated by US, Japan, and China. The German political and economic elites remain loyal to the 19th-century Deutscher Zollverein concept that ran its course and died out as nationalism polarized the members. For now, the EU has strong interests beyond economic to stay unified. However, if a series of crises hit the weaker members, the stronger creditor EU countries are establishing mechanisms now to make certain that their national interests are protected in the future.

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