World bet on the eurozone focuses on Greece; EU in difficult position

Greece’s failure to respond to the demands by international markets for a tighter fiscal policy than envisaged in its three-year Stability and Growth Program and economic structural measures has made things worse, sowing the seeds of a credit crunch with immense economic and social implications. The ball is now in the premier’s court. Greece invited worldwide attention by first allowing the 2009 budget deficit to jump to 12.7 percent of gross domestic product and by then moving hesitantly to tackle the huge budget deficit while admitting its statistical data had been falsified. In doing so, it was downgraded to the B category by Standard & Poor’s and Fitch Ratings and understandably breathed a sigh of relief when Moody’s downgraded it just one notch, keeping it in the A category, with a negative outlook. It should be noted that had all three agencies lowered it to the B category, Greek government bonds would not be acceptable for European Central Bank repo funding when the ECB decides on the pre-crisis rules widely expected next December. It is therefore no surprise that the country’s stock and bond markets have been hit by heavy liquidation from both traditional institutional investors, who seek to limit the risk of their portfolios, and speculators since December 2009. The number of hedge funds and others betting that Greek yield bond spreads will widen further against German Bunds has increased vastly, as earlier bets turned out to be profitable and the government disappointed the international markets when it unveiled its 2010-2012 Stability Program. Even worse, Greece became part of a world bet on the euro and eurozone itself. By putting pressure on Greek spreads and, to a lesser extent, the bonds of other peripheral European Monetary Union countries with large budget deficits, the markets tested European Union authorities’ credibility and resolve. With Greece’s woes threatening to contaminate other weak eurozone countries, known as the PIGS (Portugal, Italy, Greece, Spain) of Europe, the markets know that the EU authorities, even unwillingly, will have to intervene to help Greece. But EU authorities also know very well that any intervention will have to be preceded by a Greek package of additional restrictive fiscal and structural measures to ensure that the budget deficit targets set in the Stability Plan will be met if they are to safeguard their credibility. If the Greek government does not reciprocate, the EU will find itself in the delicate position of picking between two choices: either leave a member state to protect its credibility on its own but risk a similar episode in another of the PIGS later or intervene and risk weakening the euro further and making the cost of borrowing more expensive even for core eurozone countries, such as Germany and France. It is more rational to assume that the first choice is more sensible from their point of view but it does not have to come to that and should not. The Greek government can move quickly to address the demands of the markets and avoid a credit crunch while providing the EU with a strong argument to step in and help. According to different accounts, Prime Minister George Papandreou is now fully aware of the magnitude of the crisis. It is therefore up to him to give the green light to Finance Minister Giorgos Papaconstantinou to announce an additional set of measures to boost tax revenues and cut spending. Unfortunately, the indecisiveness of the Greek administration in the eyes of the markets calls for even tougher measures than perhaps would have been enough to satisfy them back in November or December. Therefore, it should make sure that the additional package includes some true spending cuts to entertain the idea that Greek measures are skewed heavily toward more taxes. Credit rating agencies and markets know very well that tax evasion may indeed be a big problem in Greece but can offer returns in the medium term if combated. However, they also know that general government expenditure shot up to 50.1 percent of GDP in 2009 from 44.4 percent in 2007 and 42.9 percent in 2006, while revenues fell to 37.3 percent of GDP in 2009 from 40.4 percent in 2007 and 39.7 percent in 2006. In other words, the deficits widened because expenditures exploded in 2008 and 2009, while revenues simply deteriorated. The economic policy decision that has to be taken by Papandreou in the next few days, or couple of weeks at most, is the most crucial taken by any Greek prime minister in decades. For the sake of the country and future generations, he has to make the right one.

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