Greece got a little breathing room. The rest of Europe didn’t. Yields on Spanish and Italian bonds soared to euro-era highs and European stocks slumped on June 18, the morning after Greek voters gave pro-bailout political parties enough support to form a parliamentary majority.
The message was clear: Even if Greece has stepped back from the brink of a euro-zone exit, that hasn’t slowed the spread of the financial crisis across the region. Investors are now demanding 7.14 percent returns on 10-year Spanish debt, above the 7 percent threshold that forced Greece, Ireland, and Portugal to seek bailouts. Italian 10-year debt is at 6.07 percent. Depositors have withdrawn tens of billions of euros from southern European banks in recent months.
Even as European Union leaders sent post-election signals that they’d compromise on Greek austerity measures to keep aid flowing to Athens, there was more scary news from Madrid. The Bank of Spain reported that bad loans reached 8.37 percent of total lending in April, an 18-year high. With the Spanish government piling up more debt in the aftermath of a €100 billion ($126 billion) bank rescue agreed this month, “The probability is rising that it will be asking for a bailout for the sovereign,” says Craig Veysey, head of fixed income at principal investment Management in London.
Sandra Holdsworth, a fund manager at the Kames Capital unit of Dutch insurance company Aegon, put it in even starker terms, saying Spain was “doomed” to a bailout. “Only a move, or even a sniff of a move, toward a fiscal union will encourage investors back into problem countries on a long-term horizon,” she wrote in an e-mailed note.
Fiscal union, simply put, means that Germany and other northern European countries with strong credit ratings would accept higher borrowing costs so that troubled southern European countries could borrow more. Berlin is having none of it. In interviews after the Greek vote, a representative of the German finance ministry reiterated the government’s opposition to jointly financed debt instruments, such as euro bonds and shorter-maturity euro bills.
It’s not even clear how much leeway the Germans are willing to grant Greece. A spokesman for European Council President Herman van Rompuy told Bloomberg Television that the European Union would consider “some adjustment” in the austerity measures required for Greece to receive additional aid—which is urgently needed, as the government could run out of money by July 20. The International Monetary Fund issued a statement that it was “ready to engage with the new government.”
But German Chancellor Angela Merkel left little wiggle room, telling reporters on Monday before a Group of 20 summit, “There can be no loosening on the reform steps.” A spokesman for Merkel said she told Antonis Samaras, leader of the pro-bailout New Democracy party, by phone after the party’s narrow election victory on June 17 that she hoped Athens would honor its commitments under the current aid agreement.
Even if Greece gets additional help, its future within the euro zone is far from assured. A softened bailout package might allow Greece to reduce annual interest payments by €5 billion while extending the repayment period, analysts at Morgan Stanley said in a June 18 report. But they predict that won’t be enough to return the country to solvency. Athens has failed to meet targets for tax collection, state asset sales, and public procurement that were required under the €240 billion bailout package it has received so far.
With the economy mired in recession and unemployment above 20 percent, Greece has little hope of generating more revenue or attracting investment. “The election has solved little and in our view is actually just another iteration toward the risks of a euro exit,” Harvinder Sian, senior rates strategist at RBS in London, told Bloomberg News. “The adjustment path is likely to remain too much for Greece to bear.”
With reporting by Emma Charlton, Simon Kennedy, and Lukanyo Mnyanda of Bloomberg News