- The Washington Times - Friday, April 23, 2010

Greece’s debt crisis again sent shock waves through global markets Thursday, pushing the nation closer to a rescue by the European Union and International Monetary Fund and deepening concern about wobbly finances throughout the eurozone.

Wall Street credit agency Moody’s Investors Service further downgraded the debt of the beleaguered nation, raising fresh questions about whether it will be able to repay its massive debts and forcing up the interest rates that Greece must pay close to double-digit levels.

Moody’s took the action as the EU raised its estimates of Greece’s budget deficit this year to 13.6 percent of economic output - the second-highest in the eurozone after Ireland’s - leaving Greece even further from achieving the fiscal stability it needs to cure its budget and economic woes in the face of persistent protests by government labor unions.

“Greece’s difficulties are spilling over into other Eurozone economies, with Portugal looking to be the next major economy to fall into the debt abyss,” said Karl Schamotta, a market strategist at Custom House, a Canadian foreign-exchange firm.

Europe’s currency, the euro, plunged to its lowest point in nearly a year, and “even Germany, paragon of fiscal virtue though it is, has been hit by the shift in investor sentiment,” he said. Germany on Wednesday was unable to sell bonds at the usual low rates it pays, about 3 percent.

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“This phenomenon underscores the risk that the European Union faces: If leaders are not able to take swift and effective action within a relatively short time period, widening contagion could easily derail the economic recovery and throw currency markets into turmoil,” Mr. Schamotta said.

The Greek drama both benefits and threatens the United States and its markets. In the short term, the crisis drives investors from European markets into the safe haven of U.S. Treasury bonds, helping to finance the burgeoning U.S. debts and lifting the value of the dollar.

But it also undermines investor faith in stock markets in the U.S. and elsewhere by raising worries about a spreading debt crisis and a relapse into recession in Europe, and it serves to remind investors that the U.S., whose own budget deficits are projected to stay above $1 trillion for years to come, could someday find itself in dire straits like Greece.

Events in Athens show how the failure to rein in debt can result in a quickening downward spiral. Moody’s analyst Sarah Carlson, who downgraded Greece’s debt to the lowest A rating of A3, noted that Greece’s situation has worsened even though the nation has stuck to a tough program of budget cuts and tax increases aimed at reducing the deficit by four percentage points.

The budget cuts and market crisis have plunged Greece’s economy into a severe slump, making it harder for the country to dig itself out, she said.

Moreover, despite the “courageous but unpopular fiscal adjustment” and “painful economic restructuring” to which Greece’s government has agreed, the country is meeting resistance to its efforts from abroad, she said.

Financial markets have proved to be deeply skeptical that Greece can resolve its problems, while efforts to mobilize a rescue plan in Europe have been “fractious,” making it “significantly more difficult for Greece” to stay on course to reduce its debts, she said.

Resistance to a bailout remains strong in EU public opinion, particularly in Germany, and questions have been raised whether legislators in Germany or elsewhere in Europe will even agree to any rescue plan arranged by the heads of state. Germany also faces a court challenge to the constitutionality of any bailout plan.

Greece has begun talks with the IMF on a three-year program that would restructure the Greek budget and economy in return for at least $59 billion in financial assistance.

Most analysts expect Greece to need to tap into the funds within the next few weeks. The exact role the IMF will take in the rescue is still being negotiated, but the international financial firefighting agency will have to take the lead, given the reluctance of some EU members to contribute.

Further complicating matters, some EU members that have been asked to pony up assistance - particularly Spain, Portugal and Ireland - have serious budget problems that could force them to seek bailouts themselves in coming months, analysts note.

The growing IMF role in the bailout raises fears among investors that one of the remedies adapted will be the traditional harsh restructuring of debts the IMF imposes on client nations - a bankruptcy-type process that determines winners and losers among investors in the country’s debts.

Those fears have further forced up the interest rates investors are demanding from Greece, prompting the IMF to deny Thursday that it is seeking a restructuring of Greece’s debt.

“It is clear that the Greek situation is a very serious one,” IMF chief Dominique Strauss-Kahn said in Washington, where he is to meet with Greek Finance Minister George Papaconstantinou on Saturday. “There is no single way, no silver bullet, to solve it in an easy manner.”

One technique the IMF has employed in the past is not possible with Greece - a devaluation of the currency to make it easier to service its debts while giving a lift to the country’s exports and economy.

The European Central Bank would strongly resist any pressure to significantly devalue the euro, as would other EU members such as Germany.

But the debt crisis and spreading economic problems in Europe already have accomplished at least a mild devaluation of the euro. Worth about $1.33 in trading Thursday, it is down by about 15 percent from its level before the Greek debt crisis broke in December.

“Certainly the euro has fallen far and fast over the past several months,” said Vassili Serebriakov, currency strategist at Wells Fargo Bank. But he noted that the euro remains far above “purchasing power parity” with the dollar, which is the level at which the currency was launched in 1999.

“There is ample room for the euro to decline further,” he said, predicting it will fall to $1.25 or below.

• Patrice Hill can be reached at phill@washingtontimes.com.

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