The European Debt Crisis, A Reality Check
(eToro Blog) Despite considerable efforts by the European Union, the European Central Bank and the International Monetary Fund, the European debt crisis remains intractable. On Friday, Greece prepared to impose additional austerity measures, along with privatization plans to stave off defaulting on its sovereign debt.
Friday's announcement by Greece included additional fiscal savings of €6.4B and came after the IMF stated it would release the fifth aid installment of €12B only if Greece met its financial obligations for the next year.
The latest Greek debt proposal would run through mid-2014 and involves the limited participation of private sector investment, like the Vienna Initiative created in 2009 by the EBRD or European Bank for Reconstruction and Development.
The Vienna Initiative was intended to support Central European nations affected by the economic crisis. Its purpose was to involve private creditors with organizations like the IMF, ECB and other world financial institutions to prevent capital outflows and a regional banking crisis.
Applying such a plan to Greece may not be feasible due to its level of indebtedness and inability to pay, making a reality check especially pertinent. Nevertheless, talks now underway may yield a creative solution once an agreement is reached and the proposed measures take effect.
One creative solution might be the legal creation of a "buffer zone," which could allow a country to fail without affecting its neighbors. While that concept continues to be open for debate between the European Central Bank and the various governments of the European Union, clearly, without such a mechanism, there is risk for further deterioration.
Adding to Greece's woes, Moody's Investor Services downgraded Greece's sovereign debt rating from B1 to Caa1 on Wednesday, increasing the likelihood of a default to 50%. Moody's then downgraded the deposit and senior debt ratings of eight Greek banks on Friday.
The problems with Greek debt - along with that of other debt-ridden members of the Eurozone, such as Portugal, Ireland, Spain and Italy - have no easy solution, and financial markets are justifiably worried that raising the capital to pay off such debts might bring down the current European financial system.
Irrespective of Greece's forthcoming aid package, the fear of contagion, specifically from Portugal to Spain, the largest "troubled" economy, is profound. While a hit to Portugal is worrying, a hit to Spain could be impinging on catastrophic, especially when Spain's "hidden" debt becomes "actual" debt.
Later this week, the ECB will be meeting and is likely to discuss the timing of a hike rate to combat rising inflation. This may support the Euro temporarily, but could choke off the nascent economic recovery. Too, if a solution to the debt crisis is not implemented soon, the Euro could well fail to remain viable in its present form and sell side pressure could hit the Euro vigorously.
While eToro analysts remain bullish for the Euro against the U.S. Dollar, especially given the likelihood of an ECB rate hike in July and another in September, the fly in the ointment remains Spain and its hidden debt. If that risk is not removed from the equation, the Euro could be hit once again.
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