Sovereign debt crisis looms over global recovery despite Greek bailout

03/05/2010 | Sid Verma

Sovereign debt burdens in the West still threaten to torpedo the global economic recovery, despite Greece’s historic bailout yesterday from the European Union and the IMF, experts have warned

Sovereign debt burdens in the West still threaten to torpedo the global economic recovery, despite Greece’s historic bailout yesterday from the European Union and the IMF yesterday, experts have warned.

“No-one should underestimate the risk of an economic downturn in the eurozone due to large government debt burdens,” said Gerard Lyons, chief economist at Standard Chartered in Tashkent yesterday.

As Emerging Markets went to press, Greece agreed to budget cuts estimated at 13% of GDP, and structural reforms, in return for a bailout package of more than 100 billion euros. The deal was due to be approved by EU finance ministers late last night.

The move would cover its financing needs for three years after investors boycotted Greek government bonds amid fears the country would default on its debt.

Greek prime minister George Papandreou said in a televised address yesterday that while the deal will require big public sacrifices, the nation must choose between a rescue and an economic collapse.

But leading officials including French foreign minister Bernard Kouchner warned that Greece’s financial lifeline will not stem a fiscal crisis that could spread through the euro region, in particular Portugal and Spain.

“In the near-term, the bailout package will help to stabilize markets, but at some point the EU will come to the fork in the road and must agree to a political union else the eurozone will be vulnerable to sovereign debt crises” due to a lack of fiscal co-ordination in the 16-member currency zone, said Lyons.

Jean-Michel Six, chief Europe economist at Standard’s & Poor’s (S&P) rating agency said: “Greece will still need to rely on international markets, since this is only a three-year plan. They will need to implement big reforms to bring down the deficit: only then will confidence return.”

It was S&P whose downgrade of Greek and Portuguese government debt last week triggered a surge in Greek borrowing costs that left the government unable to finance its deficit in the market.

Lyons at Standard Chartered said: “the best way to reduce government debt is through growth and the fact that eurozone growth prospects are poor, suggests the debt problems will loom large for the coming years.”

The Spanish government’s interest payments on its debt were 4% of its revenues in 2006, and have risen to 7% today. For Portugal and Greece, respectively, the proportions were 6.4% and 10.3% in 2006 and 7.1% and 15.1% in 2010.

ADB chief economist Jong-Wha Lee said the stability of the eurozone rests on the “credibility of the Greek government’s success” in fulfilling the EU and IMF financing package.

But he downplayed down the risk of a negative growth shock in Asia on the back of southern Europe’s government debt burdens due to “Asia’s strong economic fundamentals”.

Instead, high eurozone debt is likely to drag down regional growth, crowd out private sector borrowing and trigger the European Central Bank’s to keep interest rates low for a prolonged period, said Lyons. “This will further exacerbate the problem of large-scale inflow of capital into Asia and increase the risk of asset bubbles.”

Nevertheless, policymakers in Tashkent yesterday stuck an upbeat tone on news of the Greek bailout. “With the support of the EU and of the international institutions, we are confident that Greece will be able to tide over the crisis,” said China’s finance minister Xie Xuren yesterday.

Six of S&P said: “The Greek debt crisis is providing a political incentive and boosting domestic opinion in favour of government deficit-cutting programmes in other economies in the region.”

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