euinside

Cause and Effect in European Politics and Law

Financial Ebola is spreading across Europe

Ralitsa Kovacheva, April 29, 2010

The Greek financial virus is spreading like a wildfire across the euro zone. After it took its first victim (aside from Greece) Portugal on Tuesday, a day later it stroke the forth largest economy in the euro zone, that is currently holding the Presidency of the European Union - Spain. The credit rating agency Standard and Poor's downgraded Spain's rate from AA plus to AA, arguing that the country would reach lower growth than expected. As a result the price of Spanish 10-year bonds jumped up to 4.127 percent and shares at the Madrid stock market fell down by 3 percent. In the same time the euro hit a one-year bottom.

According to the head of the Organisation for Economic Co-operation and Development Angel Gurría, the situation was no longer a matter of risk of contagion because the epidemic is already a fact:

“This is like Ebola. When you realise you have it you have to cut your leg off in order to survive.”

As euinside wrote, currently a rescue package is being negotiated for Greece. It is expected the Eurogroup leaders to gather on May 10th to vote on the package. The tension skyrocketed after reports that Greece would need - 45 billion euros but only for the first year of a three-year long agreement. According to financial analysts, the lack of certainty whether Greece would get the money worsened the situation for Portugal.

Financial markets are not convinced that the governments from the Economic and Monetary Union would have enough will to meet their commitments. Moreover, when the rescue mechanism for Greece was agreed, it was explicitly said that it would apply for Greece only. On May 12 the European Commission will present its proposal for financial reform, including a mechanism for solving such crises. However, until then it is uclear how the EU would react to a second Greece.

“We, of course, expect that credit rating agencies, like other financial players, and in particular during this difficult and sensitive period, act in a responsible and rigorous way”, said a spokesperson for Michel Barnier, EU's internal market commissioner, quoted by the Financial Times.

Credit rating agencies were often criticised for their role in the financial crisis, but their views are still closely watched by investors, concerned about deteriorating public finances of some of the world’s most heavily indebted countries, the newspaper commented.

In an article published in the German newspaper Handelsblatt, Spanish prime minister José Luis Rodríguez Zapatero called for enhanced fiscal discipline in the eurozone and greater co-ordination of economic policies:

“Stability in the eurozone is essential for all member countries, not only Greece. Consequently, it is vital that we bolster fiscal discipline between member states and guarantee strict compliance with the Stability and Growth Pact."

According to Zapatero, "even though our debt level is already relatively low, at 20 points below the eurozone average, the Spanish Government is fully committed to fiscal consideration in order to achieve a balance in our primary budget in 2013.”

The Spanish finance ministry forecasts economic contraction of 0.3 % this year, followed by 1.8 % growth in 2011, 2.9 % in 2012 and 3.1 % 2013. But Standard and Poor’s forecast is for 0.7% average growth per year by 2016, and the previous expectations of the agency were for 1% annually. By the way, such an optimism was expressed by Greece a year ago.

Last May the then Economy and Finance Minister Yiannis Papathanassiou commented on European Commission’s spring economic forecasts, saying that Greece was showing stronger resistance compared to other euro zone countries. The finance ministry is more optimistic and is sticking to its anticipated expansion rate of 1.1% for this year (against the background of Commission’s forecast for negative growth rate of 0.9% in 2009), because "the Commission’s latest forecasts have not taken into account recent measures taken by the government”, the minister said

Sounds pretty familiar, doesn’t it?

Now we all see how optimism can turn into hysteria. Or Ebola, as Gurria says. The question is that Ebola's mortality rate is almost 100%. And cutting limps doesn’t help. The only way to limit financial contagion is to isolate the infected (which is hard and works only for a short time) or to cut bad financial practices of governments. No matter how much it might hurt.