Wednesday, May 5, 2010


• The impact of the financial crisis and its ensuing global recession on public finances has raised red flags regarding sovereign debt sustainability in advanced economies in the eurozone.

• Projections based on fair assumptions suggest these countries are on an unsustainable trajectory unless they embark on serious fiscal consolidation programs, achieve significantly higher economic growth rates, or reduce their projected unfunded age-related spending

• The events taking place in the last few days highlight the need for immediate and decisive action from European authorities to contain the risks of contagion

• Assuming financial markets are able to surpass the near-term challenges, the widespread need for fiscal consolidation still paints a eurozone medium term outlook with slower economic growth, a weaker euro and a looser monetary policy from the European Central Bank.

Policymakers across the eurozone are receiving a rude awakening to the pitfalls of having allowed government debt levels to escalate unchecked. Greece was thrust into the spotlight when market participants became aware that it would have difficulty rolling over US$10.6 billion in maturing debt on May 19th. But Greece is only one among eight European countries – France, Germany, the United Kingdom and the disparagingly nicknamed PIIGS (Portugal, Ireland, Italy, Greece, and Spain) – that are under market scrutiny for unsustainable debt levels. In fact, Spain and Portugal have recently experienced debt downgrades by a major rating agency, and the stakes are rising that others may follow. Debt downgrades start a vicious cycle which pushes up the cost of borrowing, and this, in turn, makes it even harder for governments to meet near-term debt payment obligations. At this stage, a debt default by Greece or any one of the other at-risk European countries is becoming increasingly likely. All of these ‘at-risk’ countries are set to confront ballooning debt-to-GDP ratios unless there is a radical change to their fiscal approach.

And, if you think the joint eurozone-IMF financial package for Greece that is currently afoot will be the saving grace, think again. There is no guarantee that this will be sufficient to reassure investors regarding the outlook for the other debt-beleaguered euro members. With yield spreads rising rapidly in a matter of days and with sizeable upcoming roll over needs of the other PIIGS (US$ 588 billion from May-December 2010), Greece’s atonement today could be Portugal’s, Ireland’s, Italy’s or Spain’s tears tomorrow.

To read the full report: SPECIAL REPORT