Fears are growing that the Greek debt crisis could spread rapidly to other hard up nations in the Eurozone, with the Republic of Ireland high on the ‘at risk’ list.
The euro slumped to a one-year low against the dollar yesterday, despite the best efforts of European finance chiefs to reassure nervous investors that Greece’s economy would not be allowed to go under.
Ratings agency Standard & Poor’s which, sparked a minor meltdown on stock markets by downgrading Greece’s credit rating to “junk” status on Tuesday, yesterday cut Spain’s debt rating over concerns about its ability to recover from the property market crash.
Irish government debt took a hammering on bond markets, with interest rates rising faster than those of either Spain or Portugal, although the head of the Irish debt agency pointed out that the Republic does not need to borrow on the panicky bond market at present.
Investors are worried several other euorzone countries with large debts — including the Republic — will not be able to service those debts in the long term without some kind of outside assistance.
The Republic is still viewed as one of the most at risk regions because its fiscal deficit is the third highest in the eurozone at more than 14%. While investors do not think the Republic currently faces the same difficulty paying interest, the cost of borrowing is rising because of the effect the crisis on market confidence.
Alan McQuaid of Bloxham said it was clear the Republic remained “vulnerable to external stresses in financial markets”.
But Rossa White, chief economist at Davy Stockbrokers, said he didn't expect the interest, that the Republic is having to pay on its bonds, will remain at current high levels.
The escalation of the Greek crisis came on a day when Davy released a report suggesting the Republic’s economy, which returned to growth in the first quarter of 2010, was seeing an improvement in its export markets.
Respected economist Willem Buiter of Citi also said he didn't expect the Republic to be overly troubled in the short term.
“'Barring a sudden and implausible implosion of the collective common sense displayed in the past year, Ireland is unlikely to be tested too severely by the markets,” he said.
Greece has called for funds from a €45bn (£39bn) bail-out package, but some European countries still have to approve the aid and fears are rising over whether the money will arrive before a bond payment deadline of May 19.
Germany is holding out for more economic reforms from Greece before agreeing to an unprecedented bail-out plan to restore the euro's fortunes.
Why is a high deficit in just one country, Greece, causing such widespread problems in markets?
Greece is only one of several eurozone members with a huge fiscal deficit. The markets are worried these countries — Greece, Portugal, Spain and Ireland — will not be able to service their debts in the long term without some kind of outside assistance.
Markets are also worried that debt levels will act as a brake on economic growth, making it harder for countries to improve their budgetary positions. Ratings agencies are also making markets nervous by questioning the credit worthiness of some countries, like Spain yesterday for instance.
But haven't several eurozone countries had debt problems for a long time?
Yes, countries like Italy and Greece have had high debt levels for years, but the bond market, which allows countries to borrow, has become more concerned about the debt levels since the financial crisis began. The level of borrowing being done by major western economies, including the UK and the US, is also at unprecedented highs, making markets nervous about whether there will be enough buyers for all the debt.
Where does Ireland fit into all of this and how vulnerable is the Irish Exchequer?
Very vulnerable. Ireland has the highest fiscal deficit in the eurozone at over 14% and is being charged the third-highest interest rate after Greece and Portugal.
While the government has improved the budgetary position, more expenditure cuts and tax rises are still needed. Markets do not believe Greece can service its debts alone. They don't believe that Ireland is in the same category, but that view could change.
Borrowing costs are rising for Ireland and if that remains the position, it will hurt the exchequer in terms of higher debt-servicing costs.
Is the euro under pressure and could the eurozone itself be threatened by this crisis?
Yes, the euro hit a one-year low against the dollar this week as investors worried about the problems in Greece spreading elsewhere. The single currency slipped to $1.3143 against the dollar as traders looked for safe harbours, one of them being the US dollar. The dangers to the eurozone are real as many observers question whether Germany, the largest member, is prepared to be a lender of last resort to smaller, indebted countries.
Already the Washington-based IMF is helping to bail out Greece, but nobody knows what will happen if other countries are shunned by the bond markets and have to find other ways to borrow money.
However, the break-up of the eurozone remains a very remote possibility at this point.
The main impact of the Greek crisis has been on the Eurozone sovereign debt markets.
The rising cost of government borrowing has put fragile Greek finances under more pressure. This has spread to other Eurozone economies particularly Portugal, Spain and Ireland.
The cost of government borrowing has risen in Ireland. In December the Republic’s Budget brought its cost of government borrowing over 10 years down.
But concerns over Greece have triggered a rapid rise in the cost of borrowing. Irish government borrowing is now 5.3% — more than the UK (3.93%) but lower than Portugal (5.8%).
The implications of this for Ireland will be that the significant levels of government borrowing that Ireland must make will pay an even higher interest rate. If Ireland's credit rating was to be downgraded further, the cost of borrowing will rise.
The Greek crisis and its wider contagion within the eurozone will be a key driver of euro weakness. This will help exporters in the Republic to start to regain some lost price competitiveness. If the German Government fails to back the Greek bail-out one can expect a further bout of renewed euro weakness, the cost of borrowing for Ireland will rise further and Ireland's current rating will be put under further pressure.
Richard Ramsey is chief economist for Ulster Bank in Northern Ireland