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Risk Of Contagion Seen From 'Greek Disease' As EU Ponders Options

  • Breffni O'Rourke

Greek Prime Minister George Papandreou has submitted a recovery plan to Brussels.

Greek Prime Minister George Papandreou has submitted a recovery plan to Brussels.

PIIGS, they call it. But it has nothing to do with farmyards.

It's the acronym for a group of five European Union countries -- namely, Portugal, Italy, Ireland, Greece, and Spain (PIIGS) -- that are running massive budget deficits coupled with weak recovery prospects.

These nations are all members of the common currency's eurozone, and the uncertainty surrounding their financial problems is already driving down the value of the euro on money markets. The common currency in the past week fell to its lowest level in six months against the dollar.

At the center of the storm is Greece, which has a government deficit of 12.7 percent of gross domestic product (GDP) and debt which at $294 billion is larger than its entire GDP.

External investors are already worried about possible default by Greece or other PIIGS states on sovereign debt repayments. That would be a major challenge for the eurozone that could be expected to further undermine the euro.

'Very Real Risk'

Analyst Simon Tilford, the chief economist at the Center for European Reform in London, says its hard to gauge the overall impact of a default on debt by a eurozone member. "There is a risk at some point of Greece defaulting on its sovereign debt," Tilford says. "I think there is a very real risk of that. Then, it's very difficult, really, to say what would happen."

There is a very real threat of contagion spreading to other countries in the eurozone, like Spain and Portugal, which are suffering similar difficulties with the size of their budget deficits.
The common currency is only 11 years old, and practically any policy decision must be taken without a guiding precedent based on past experience.

Making things doubly awkward is that the eurozone is a monetary union without being a fiscal union. That means that each of the 16 governments of the eurozone has control over its own budgetary and fiscal actions, with the European Commission having only a limited right to interfere. The commission can recommend a course of action, but implementation is up to the individual country involved. The European Central Bank's (ECB) role, in turn, is limited to setting common interest rates.

The commission is due to make public today its assessment of the recovery plan submitted to Brussels in January by Greek Prime Minister George Papandreou. Reports say the commission will recommend further tightening of the already severe austerity package, which foresees big cuts in government spending.

And in Frankfurt, policymakers at the ECB at their meeting on February 4 are seen as certain to leave the base interest rate at 1 percent, which favors the weakest economies like those of PIIGS.

Today, the European Commission endorsed the recovery plan submitted to Brussels in January by Greek Prime Minister George Papandreou. At the same time, the commission said it is placing Athens under permanent monitoring to make sure it is fully implementing the austerity measures.

EU Economic and Monetary Affairs Commissioner Juaquin Almunia threw the commission's support behind Greece at a news conference in Brussels. "We share the objectives and the targets established by the Greek authorities in their stability program to correct the imbalances of the Greek economy, both the fiscal imbalances and other economic imbalances," Almunia said. "We share the ambition of the program, and we consider that the program is ambitious. And we consider that the program, in terms of objectives, in terms of targets, is achievable."

On money markets, the euro rose against the dollar on the news of the commission's endorsement.

Speaking on February 2, Greek Prime Minister George Papandreou blamed outside speculators for many of his country's troubles. "Greece -- with its own responsibility and to be frank the responsibility of the previous government -- finds itself at the center of an unprecedented speculative attack that doesn't concern only us," he said. "Many bet on the bankruptcy of countries. Others bet on euro-dollar parity.

"But the result is the same -- the strangulation of our economy, with the rising of spreads [higher interest rates on government bonds that raises the cost of borrowing] that are completely unjustified in relation with the real situation of the Greek economy."

Most economists are unconvinced by that argument. And EU and ECB officials are pondering what to do if any of the PIIGS group needs a bailout to prevent it defaulting on its debt. The European Commission has no power to provide cash for a bailout, and one suggestion is that individual EU member states could lend the prospective defaulter money on a bilateral basis.

'Threat Of Contagion'

Greece's problems are mirrored, though less dramatically, by the other members the PIIGS group -- Portugal, Italy, Ireland, and Spain. Neil MacKinnon, a global strategist at VTB capital in London, says Greece's troubles could easily spread.

Portugal's Prime Minister Jose Socrates
"There is a very real threat of contagion spreading to other countries in the eurozone, like Spain and Portugal, which are suffering similar difficulties with the size of their budget deficits," MacKinnon says. "So this is a big issue for the markets at the moment."

Portugal's Prime Minister Jose Socrates last week objected to his country being lumped together with Greece, decrying the comparison as "ludicrous." He was unveiling his austerity program to cut Portugal's record deficit of 9.3 percent, which is three times the deficit rate set by the EU for eurozone members. He estimated Portugal will come within the 3 percent limit by 2013, but analysts say weak growth may undermine those plans.

Ireland is in the same position, with an 11.7 percent deficit that requires a stiff austerity program, the implementation of which depends upon public acceptance of harsh cutbacks in public spending.

But Portugal and Ireland, and to a certain extent Greece, are small, peripheral members of the eurozone. Their influence over the stability of the euro is slight compared to the potential of Spain or Italy to damage the eurozone.

Italy's finances have for years been in disarray. Its public debt is due to reach 120 percent of GDP this year. Economists say Spain -- for years a star performer among EU economies -- presents the biggest potential headache.

Before the recession, some analysts had even forecast that Spain could overtake Germany in per capita income by 2020. But it was not to be. Spain's massive building boom, which accounted for an amazing 16 percent of the country's GDP, collapsed, and Spain took a nosedive. Unemployment now tops 19 percent -- the highest in the euro area -- and the budget deficit for 2009 is estimated to be over 11 percent.

'Absurd'

Could the pressures on the euro cause the departure of any eurozone member from the zone?

ECB president Jean-Claud Trichet has ruled that out as "absurd." But New York-based currency expert Nouriel Roubini, speaking at the World Economic Forum in Davos, said he expects the zone to splinter eventually.

"If you had asked me that question two or three years ago, I would have said the chances were zero [of a euorozone split] and that would have been the answer of most economists in the financial market," MacKinnon said. "But it is very interesting that that question is now being asked, and many economists believe there is a risk."

Departure offers no immediate solution to nations deeply in debt because of the expense of reestablishing a national currency. In view of the poor economic state of the country involved, its new currency would probably fall precipitously, scaring away foreign investment, and making payment of external debts even harder.
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