Debt fears spread further across Europe: Maley

European markets were again in a state of agitation overnight, as investors feared a domino effect, with concerns over Greek debt crisis spreading through the eurozone, and with indications the price tag for bailing out Greece is likely to hit $US180 billion.

Contagion fears were exacerbated when the ratings agency Standard & Poor’s cut Spain’s credit rating by a notch, a day after it downgraded Portugal and cut Greece’s status to junk. The ratings agency said Spain faced a period of sluggish economic performance and expressed concerns about the country’s inflexible labour market, predicting the country’s unemployment rate would likely reach 21% this year.

Meanwhile, German chancellor Angela Merkel came under massive pressure to give her blessing to a joint European Union-IMF bailout for Greece.

The heads of both the European central bank and the IMF travelled to Berlin overnight in a bid to clear the German roadblock. The European Central Bank chief, Jean-Claude Trichet, said it was an “absolute necessity” for Germany to decide rapidly, while IMF chief Dominique Strauss-Kahn, said “confidence in the eurozone” was at stake.

The European Union and the IMF are also putting the Greek government under huge pressure to approve a three-year austerity budget within the next few days. But a potential stumbling block to the negotiations has emerged, with Le Monde reporting Greece’s employment minister, Andreas Loverdos, as saying the country is refusing to adopt some of the wage cuts that the IMF and the European Union are demanding.

At the same time, it is becoming increasingly evident that the cost of the Greek bail-out will be much higher than initially thought.

Der Spiegel reports that German Economy Minister Rainer Brüderle has confirmed the EU-IMF rescue package could cost $US180 billion over the next three years. Under the current plan, Germany was expected to contribute $US11.2 billion each year to the package, but Brüderle told reporters he could not exclude the possibility that the amount could be higher.

There is now growing agitation in Germany regarding the cost of the Greek bailout and the damage it will do to Germany’s already stretched finances. Conservative newspaper Frankfurter Allgemeine Zeitung, lambasted Merkel’s governments for running up big budget deficits and for spreading Greece’s credit risk to the “expense of the general public”.

Germany’s Merkel is delaying committing to German participation, saying that she would wait until negotiations between EU, ECB and IMF and Greece over a tough three year austerity plan for the country were resolved, “I hope that this will happen by the end of the week. Everything else depends on that,” she said. Merkel’s cabinet will discuss draft legislation on the German aid package for Greece at a meeting on Monday.

Meanwhile, figures published in Der Spiegel show France and Germany are not too far from the PIIGS (Portugal, Italy, Ireland, Greece and Spain) when it comes to swollen government debt.

Greece is the worst offender, with national debt totalling a staggering 124.9% of GDP, followed by Italy (116.7% of GDP). But the national debt burden of Portugal (84% of GDP) and Ireland (82% of GDP) is only marginally worse than that of France (82.5% of GDP) and Germany (76.6% of GDP).

In fact, under this measure, Spain is the best-performer with government debt standing at a comparatively modest 66.3 per cent of GDP.

Harvard economics professor, Martin Feldstein, is arguing that a Greek debt default is inevitable. In an article published in Project Syndicate, he says this could either involve an IMF-led restructuring of existing debt, or it could be a “soft default” where Greece pays interest on its existing debt by issuing new debt, rather than paying cash. Either way, he says, “the current owners of Greek debt will get less than the full amount that they are now owed.”

Feldstein argues that Greece’s task of reducing its budget deficit by 10% of GDP will entail huge cuts in government spending, or a dramatic rise in taxes – or likely both. This will depress economic activity so much that the government’s tax revenues will plunge at the same time as spending on unemployment benefits surges.

Feldstein says that the EU-IMF bailout package will enable Greece to stave off default for a while. But he sees this as only a temporary fix. “In the end, Greece, the eurozone’s other members, and Greece’s creditors will have to accept that the country is insolvent and cannot service its existing debt. At that point, Greece will default.”

Fears that Greece could default on its debt has seen the share prices of French and German banks plummet in recent days. French banks have nearly $80 billion in exposure to Greece, followed by Germany at $45 billion. The French bank, Crédit Agricole, has revealed its exposure to Greek debt is as much as $1.1 billion through its Greek bank subsidiary, Emporiki. Within Germany, Hypo Real Estate is estimated to have the biggest exposure at $12 billion, while Commerzbank holds $6 billion in Greek bonds.

This article first appeared on Business Spectator.