Eurozone: A string of sovereign defaults could hit Europe following austerity backlash

23rd December 2010

Writing in the latest edition of Citi's Global Economic Outlook, the bank's chief economist warns the eurozone is paralysed by a "game of chicken" between the European Central Bank and EMU governments in charge of fiscal policy.  Dr Willem Buiter argues the risks of contagion are increasing as both sides try to shift responsibility onto the other over problems in Southern Europe and Ireland.

Dr Buiter describes the EU policy response as woefully inadequate. He said: "The market is not going to wait until March for the EU authorities to get their act together. We could have several sovereign states and banks going under. They are being far too casual."

European leaders agreed new measures last week to replace the temporary €440 billion European Financial Stability Facility introduced after the Greek bailout.  The current scheme runs until 2013 when the new European Stability Mechanism takes over.

The FT reports that China has offered backing over the crisis.  It has been an enthusiastic supporter of European distressed debt in recent months.

Nevertheless, fund managers worry that European sovereign states may have to draw on EU support very soon.  Citigroup has already said Portugal could need help before the end of the year.  Spain may well follow.

On Monday, Andrew Bosomworth of PIMCO told Die Welt newspaper that Greece, Ireland and Portugal should leave the Eurozone and restructure their debts. 

(see our thoughts on why PIMCO is wrong)

Schroders' chief economist Keith Wade and European economist Azad Zagana warned: "Spreads on peripheral debt and CDS prices remain high, an indication that markets remain sceptical about the ability of countries to succeed in hitting their debt targets."

Fiscal austerity is unlikely to deliver reduced yields or budget deficits.  Growth is likely to remain weak, leaving debtor nations struggling to pay back bailout funds.  Wade and Azad concluded: "Consequently we could well see countries announcing a restructuring or rescheduling of debt repayments in order to create a sustainable path for their debt. The likelihood of a political backlash to the current austerity means this may come sooner rather than later."

Markets are likely to bring forward future events.  Countries may find funding increasingly difficult in the run up to June 2013 when the permanent EU scheme takes effect.  Attempts to secure longer term funding may precipitate a crisis and early restructuring.

Daily Telegraph readers appear to agree that more problems are likely.  expatdavid commented: "This is the inevitable result of the feckless politicians dream with the single currency being used to try and force fiscal and political union. Better that it fails now rather than later after many more billions of taxpayers money have been squandered. We have had more than enough of that already."

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