Stock markets are set for a roller coaster ride this week. While strong 1st quarter profits were reported and the US economy grew 3.2% in the first quarter, slightly short of economists’ forecast but still made for a third consecutive quarter of growth, investors were spooked by lingering doubts on the viability of Greece’s financial rescue.
Two months of wrangling on the terms of financial aid was brought to bear as Greece received a bailout of €110bn over 3 years, sponsored by the EU-IMF. The olive branch was expected after Greece’s close brush with bankruptcy last week. All hell broke loose after European Union revised upwards Greece’s 2009 deficit to 13.6% of GDP and rating agencies downgraded its credit to junk status, limiting access to fresh funds.
The first disbursement of bailout money will be made before May 19 to avert a default, but there is no guarantee financial stability will prevail in the eurozone. If Greece bite the bullet and persevere to put its finances in order, they will face a recession and deflationary pressures which will cripple their economy for years.
However, given Greece’s abysmal record in fiscal discipline, it is doubtful if the austerity measures will be implemented fully. Greece promises to cut its budget deficit to 3% of GDP by 2014, but reining in spending is a tough call, with mounting political pressure from rioting workers and pensioners. From the initial response, a deadlock may ensue and hold the economy to ransom which essentially defeats the purpose of a bailout.
It is ironic that with this bailout, bond vigilantes have shifted their scrutiny to other debt laden nations in the Euro zone. Greece is but the tip of the iceberg, they came first to the party with hat in hand and are now safe, at least for a year. A dangerous precedent has been set though. How can Europe not save Portugal or Spain after handing Greece a lifeline?
Besides the PIGS (Portugal, Spain, Italy, Greece), you can count Austria, Belgium, Hungary, Ireland, and UK in the soverign default risk category. US and Japan have worrisome debt to GDP ratios too but because the former possess a reserve currency (licensed printing press), while the latter has a springwell of domestic savings to tap on for cheap government loans, their financial woes are not expected to blowup any time soon. Read more…