Europe’s leaders may be able to avoid a default by Greece – temporarily at least – but that won’t be the end of the story. Indeed, the worry is that “the firewall that markets thought existed between Greece, Portugal and Ireland and the much bigger and systemic economies of Spain and Italy is in danger of being an illusion”, says Michael Riddell on Bondvigilantes.com.
Last week, the yield on ten-year Spanish debt hit a euro-era high as a debt auction failed to raise the targeted amount. One concern is that intensifying public anger could derail austerity measures. Another is the prospect of hidden debt on the balance sheets of regional governments. Madrid has called on the autonomous regional governments to deliver a 1.3% of GDP deficit this year. But Barclays Capital expects the figure to be 1.8%, pushing Spain’s overall shortfall to 6.5% of GDP, 0.5% more than the official target.
Nor is it yet clear how much money the government is going to have to pour into the damaged savings banks, the cajas: stress tests are due next month. Add the fact that the anaemic recovery appears to be stalling, and it’s no wonder investors are concerned that it won’t be able to get on top of its debt load.
Then there’s Italy, with almost $2trn of sovereign debt outstanding. Ratings agency Moody’s highlighted Italy’s main problems when it threatened to downgrade its debt last week. Italy’s debt is worth around 120% of GDP and, while deficits remained comparatively low during the financial crisis, a sclerotic economy means it can barely make a dent in the debt. Between 2000 and 2010, Italy grew by an annual average of 0.25%. Only Haiti and Zimbabwe fared worse, notes The Economist.
The government’s interest payments have reached 4.8% of GDP, second only to Greece’s 6.7%. The government’s weakness militates against long overdue structural reform to boost growth, says Marc Chandler of Brown Brothers Harriman. Italian bonds have come under pressure, raising borrowing costs, but are still holding up better than Spain’s, he notes. But both countries, as Edward Altman of New York University puts it in the FT, look vulnerable to “financial attack”.