A sense of panic has started to grip Europe over the
potential for Greece to default on its debts, and the
contagion to spread rapidly to the continent's other
struggling economies, it has not yet struck Herman Van
Rompuy, the president of the European Council. He insisted
on Wednesday April 28th that there was "no
question" of Greece's debts being restructured. He also
said leaders of the euro-zone countries would meet next
month to consider how to activate their proposed joint
lending programme with the IMF to support Greece.
Jean-Claude Trichet, president of the European Central Bank,
delivered an almost identical message, saying that a Greek
default was "out of the question".
The calm demeanour of Mr Trichet and Mr Van Rompuy is
not shared by the markets. On Wednesday Greece said that it
would ban the short-selling of shares for two months to
prevent speculators doing further damage to the country's
banks. The previous day, shares in Greek banks had plunged
by nearly 10% and the Athens stockmarket as a whole fell by
6% on fears that the country would soon suffer another
downgrade of its debts. Those fears proved entirely
justified. After the markets closed Standard & Poor's
heaped indignity on Greece by cutting the rating of its
sovereign bonds to "junk" status. It also cut
Greece's banks to "junk" because of their hefty
exposure to government debt.
Although the move to ban short-selling steadied
Greece's stockmarket somewhat on Wednesday, the chances of
the country defaulting on its debts were still perceived by
the bond markets as high. Spreads on Greek government bonds
(the risk premium compared with German bonds) reached a
13-year high as investors worried that the proposed rescue
plan for Greece could stall. Talks between Greece, the
European Union and the IMF got under way last week.
Greece was initially seeking up to €45 billion ($60
billion) in emergency loans from euro-zone governments and
the IMF this year, the first chunk of which will be needed
by May 19th, when the Greek government must refinance a
€8.5 billion bond. But as the crisis has worsened it has
become clear that Greece could need much more. On Wednesday
it was reported that the EU and IMF were preparing a package
worth up to €120 billion over three years-if so, the
biggest sovereign rescue yet attempted. Nevertheless, even
aid on this scale might only postpone an eventual default,
if Greece's economy fails to grow faster than its debt pile.
Investors do not seem convinced that euro-zone
governments will be able to muster the political will to
hammer out an agreement. Germany, as the largest euro
member, is vital to any effort to save Greece, but it is
wavering. German public opinion is firmly set against
dipping into the public purse to help the profligate Greeks.
Angela Merkel, Germany's chancellor, is in a tight spot. If
she agrees to extend aid quickly to Greece a voters'
backlash back home may send her party crashing to defeat in
regional elections set for May 9th. But if she sits back and
watches Greece slide towards default, the contagion is sure
to spread rapidly to other, bigger EU countries with debt
problems-Mrs Merkel could then end up being blamed for
triggering a far worse conflagration across Europe,
including a fresh banking crisis.
Fears that Greece's fiscal crunch would spread to other
euro-area countries have sent the region's single currency
reeling to a one-year low against the dollar. S&P's
decision on Tuesday also to downgrade the debt of Portugal
by a couple of notches pushed European and world
stockmarkets lower. Portugal, despite a smaller budget
deficit and lower public debt than Greece, is widely touted
as the next European country that may suffer a
sovereign-debt crisis. Portugal's slow-growing economy,
drastic loss of competitiveness and high public and private
indebtedness are all weaknesses that markets might put to
greater test.
If Portugal comes under intense pressure, contagion
might then spread to Ireland, Italy or Spain, the other
euro-area countries with some mixture of big budget
deficits, poor growth prospects and high debts. Only swift
and decisive action by the leaders of Europe's big economies
is likely to head off the current crisis. Default by a
smaller member such as Greece would be a body blow to the
euro's standing but it need not spell the end of the
currency. However, that might not be the case if the
problems spread further afield.