The eurozone crisis has gone from bad to worse. This week the crisis enveloped Italy and Spain. Spanish ten-year bond yields rose to just under 6%, the highest level since late 2000, after the ruling Socialists’ heavy defeats in regional elections. Credit ratings agency Standard & Poor’s cut the outlook on Italy’s debt. Fitch, another ratings agency, did the same to Belgium. The euro has slid to a two-month low against the dollar and another record low against the Swiss franc. “It is like a group of climbers roped together,” says John Wraith of Bank of America Merrill Lynch. “As Greece slips, it pulls down” other countries.
Pain in Spain
Investors are already nervous about electorates derailing bail-out plans or austerity packages, says Emma Rowley in The Daily Telegraph. Now Spanish regional election results have stoked fears that the central government will have trouble pushing through its deficit-reduction plan, especially with unemployment at 20% and street protests erupting. Spain has hitherto impressed the markets by slashing its deficit.
But progress so far has been due largely to central government cuts, says Jonathan House in The Wall Street Journal. Regional and municipal governments control about half of spending and haven’t made much progress. Some of the new regional governments may well “deem the deficit-reduction target for the regionsof 1.3% of GDP overly ambitious”, says Barclays Capital’s Antoni Pascual. What’s more, says House, we may now discover “piles of undisclosed debt” in local government accounts “that could undercut” Spain’s drive to avoid a bail-out. Last year, after a change of government in Catalonia, it transpired that the region’s budget deficit was over twice the previously reported size.
Italy and Belgium head for trouble
Italy’s problem is longer term. Its deficit this year is expected to be just 4% of GDP. But its overall debt pile is 119% of GDP. Getting this back to sustainable levels looks increasingly difficult. Lacklustre growth – GDP has expanded by an average of just 0.2% for a decade – and falling competitiveness bode ill. Now pro-growth reforms may get nowhere, given political gridlock. “WithBerlusconi… in legal trouble and the opposition in disarray, the country’s political risk factor is increasing,” said Lex in the FT. It’s a similar story in Belgium, where debt has reached 97% of GDP and caretakers are still in charge of the government 13 months after a general election.
Political paralysis
With political uncertainty mounting, “the market is increasingly questioning the eurozone’s ability to contain its crisis”, says Lena Komileva of Brown Brothers Harriman. A key worry has been the stand off between policy-makers and the European Central Bank (ECB) over Greece. Finance ministers have floated the idea of ‘reprofiling’ Greek debt – lengthening the maturities on it. But the ECB won’t contemplate any form of restructuring. It says that even reprofiling would make Greek debt unacceptable as collateral for loans to Greece’s cash-starved banks.
Without ECB loans Greek banks would collapse. Greece appears to have defused this row for now by reaffirming its commitment to its fiscal austerity package and a privatisation programme, which many feared it had virtually given up on. But with Greece slipping behind on its debt-reduction programme, a bigger fear remains: what would a restructuring there, or elsewhere, do to Europe’s interlinked banking system? With the eurozone’s key figures at loggerheads, and large states being roped into the crisis, the situation, says Fxpro.com’s Michael Derks, is becoming “more and more precarious”.