Euro-region governments are betting 110 billion euros ($146 billion) in economic medicine for Greece will be enough to inoculate the rest of their region from contagion.
Finance ministers approved the unprecedented bailout yesterday for Greece after a week that saw the country’s fiscal crisis spread to Portugal and Spain. At the same time, they refused to say how they would help other indebted nations if the need arose, calling Greece a “special case.”
The risk is that investors will shift attention to other euro nations in the absence of a clear aid plan for the 16- nation bloc’s weakest members. The extra yield investors demand to buy Portuguese debt over German bunds surged to the highest since at least 1997 and Spain’s IBEX 35 stock index fell the most in three months last week. The euro slid in Asia after the Greece announcement.
“It is far from assured that this program will forcefully counter contagion risk,” said Mohamed El-Erian, co-chief investment officer at Pacific Investment Management Co. in Newport Beach, California, which runs the world’s biggest bond fund. “Heavily exposed creditors” may try to head off potential losses and sell bonds, “increasing the pressure on core European governments to also provide a backstop for Portugal and Spain.”
Greece yesterday pledged to push through 30 billion euros ($40 billion) of budget cuts, equivalent to 13 percent of gross domestic product, in return for loans at a rate of around 5 percent for three years. The EU and the International Monetary Fund, which is co-financing the bailout, also agreed to set up a bank stabilization fund. Greece’s federation of civil servants responded by calling a 48-hour strike starting tomorrow.
European officials rushed to draw a distinction between Greece, whose misstated budget figures first roiled markets last year, and other countries.
“I don’t think the markets will put Portugal and Spain under attack because their situation is in no way comparable to Greece,” Luxembourg’s Jean-Claude Juncker said yesterday after chairing the talks. French Finance Minister Christine Lagarde said “Greece was a special case, because it reported special numbers, provided funny statistics.”
The IMF’s Poul Thomsen, who heads the mission to Greece, said the austerity plan was designed to “shock and awe markets and re-establish confidence.”
The euro, which rallied 0.5 percent against the dollar on April 30, weakened against 13 of its 16 most traded peers, losing 0.6 percent against the dollar and 0.5 percent versus the yen at 09:12 a.m. in Frankfurt.
“The euro will remain weak and there’ll be more bailouts,” Marc Faber, publisher of the Gloom, Boom & Doom report, said in a Bloomberg Television interview in Hong Kong. “For Greece, it means terrific austerity and terrific recession.”
Spain’s budget deficit was the third-highest in the euro region last year, at 11.2 percent of GDP. Portugal’s budget deficit was the fourth-biggest at 9.4 percent of output. Ireland had the highest deficit at 14.3 percent and Greece’s was 13.6 percent.
“Unless Portugal and Spain proactively take additional measures to bolster their fiscal and growth outlook, markets will be tempted to test whether the EU has appetite for any further rescues after the breathtakingly large commitment made to Greece,” said Marco Annunziata, chief economist at UniCredit Group in London.
The Portuguese spread surged as high as 299 basis points on April 28 and the Spanish premium rose to 113 basis points, the highest since March 2009. The Greek spread touched a record of 827 points on April 28.
At stake is the future of the euro 11 years after leaving fiscal policy in national capitals. The euro has fallen 7 percent this year as the lack of a single finance ministry made it harder for governments to agree on whether and how to rescue Greece. That in turn exacerbated a selloff in Greek bonds.
Governments first agreed to support Greece on Feb. 11 and didn’t make any concrete pledge of cash until two months later. The yield on the Greek 10-year bond, which was 6.63 percent at the start of February, stood at 8.96 percent on April 30.
Greece will eventually have to restructure its debt, undermining confidence in the euro, said Stuart Thomson, who helps oversee $100 billion at Ignis Asset Management in Glasgow, Scotland.
“The sovereign restructuring threat hangs over the euro, and makes it less likely to be a reserve currency over time,” said Thomson.
To head off future crises, EU Monetary Affairs Commissioner Olli Rehn has proposed strengthening integration over budgets, for example by requiring national governments to submit spending plans to European authorities before parliaments approve them.
Some economists say European policy makers may have to take unprecedented steps such as allowing the ECB to buy government bonds on the secondary market. European Central Bank President Jean-Claude Trichet said yesterday the central bank had made “no decision” on that.
For now, the onus is on high-deficit economies to retrench before investors force them to, says Stephen Jen, managing director of macroeconomics and currencies at BlueGold Capital Management LLP in London who also once worked for the IMF.
“Governments have to get ahead of the market, it’s no longer good enough to just do enough and that’s the challenge,” said Jen. “There will be some rally in European assets, but long-term investors are still too scared to get back in. After the rally, reality sets in.”