Equity markets in Spain and Portugal tumbled on Tuesday, undermining hopes — and politicians’ assertions — that the €110bn Greek rescue package would quell fears of eurozone contagion.
David Shairp, global strategist at JP Morgan Asset Management, attributed some of the negative reaction to the details in the aid package (and the hangover from rating agency Standard & Poor’s decision to downgrade both Spain and Portugal).
Moreover, as Shairp put it, the Greek bailout has not spelled the end of the crisis in the eurozone. Emphasis FT Alphaville’s:
There are several concerns that remain. In particular, eurozone banks have been bruised by last week’s developments, given their exposure to Greece, Portugal and Spain. Indeed, according to BIS data, at the end of 2009 it was estimated that European banks held USD236bn in public debt issued by these three countries with Greece exposure amounting to USD87bn. These holdings may have increased in early 2010 given that European banks have been heavy buyers of government bonds, as they have “played” yield curves.
Fiscal consolidation will clearly continue to be a major theme in Europe over the next few years. The key question is whether this will create a structural drag on growth in the eurozone with potential implications for trend ROEs. One analysis concluded that previous periods of fiscal retrenchment – where deficits were reduced by at least 10 percentage points of GDP – did not impede growth. But, the keys to success included an emphasis on expenditure reduction, as opposed to tax increases, as well as wage restraint to accompany currency devaluation. Two of the current problems in the eurozone are that inflation is much lower, thereby making cuts in wage growth less palatable, and that currency depreciation is not an option.
So can the periphery get out of jail? It depends on whether there can be a successful combination of expenditure reduction and expenditure switching (to rebalance growth towards net exports). A typical IMF programme relies on currency devaluation to achieve the latter, but the eurozone is constrained. Improved competitiveness can only occur by reducing domestic prices relative to trading partners – in practice involving massive rises in joblessness. But there is one way in which the periphery’s export sectors can be boosted, and that is via growth in its export markets. Since the eurozone does about half of its trade with itself, this means that domestic demand in the core nations (Germany and France in particular) needs to grow strongly and be boosted by more policy stimulus. This is unlikely and, while recent data in Europe have been encouraging, the periphery’s problems are set to be prolonged and to outlive any Greek package.
At pixel time, Spain’s Ibex index had fallen more than 400 points, or 4.2 per cent, while Portugal’s PSI had dropped 205 points, or 2.8 per cent, adding to earlier declines. In London, the FTSE 100 had shed 107 points to 5,445.
Related links:
Stability fears spread after Greek bail-out – FT
Greek bail-out welcomed by Bank of Spain – FT
Portugal pledges tough measures to cut deficit – FT
Spain and Portugal: the story so far – FT Alphaville