The EU no longer wants to monitor Greece’s finances separately in the future. Nevertheless, nervousness on the markets is increasing in view of the interest rate hike announced. The focus is on Italy.
For the first time since the debt crisis, Greece is no longer to be monitored more closely by the EU Commission. The finance and economics ministers of the euro countries decided on Thursday. As a result of the financial crisis from 2010, the country had to implement tough austerity measures under pressure from its creditors. Since 2018, Athens has been financially on its own two feet. The EU Commission still has to approve the ministers’ decision, but that is taken for granted. His country is no longer “Europe’s black sheep”, Prime Minister Kyriakos Mitsotakis commented on the Eurogroup’s announcement. Greece recently repaid the last loans from the International Monetary Fund. “This completes a painful cycle that began twelve years ago.”
However, after the interest rate turnaround in the euro zone was announced, new turbulence is looming for the heavily indebted countries in southern Europe. In July, the European Central Bank (ECB) intends to raise the key interest rate from zero to 0.25 percent. The turnaround in interest rates is already making itself felt on the bond market. Government bond prices are falling. Yields increase inversely. Investors demand significantly higher risk premiums. Market participants are primarily concerned with one thing: will these states be able to service their liabilities without government finances going haywire, even if key interest rates rise? This is especially true for the heavily indebted PIGS, the countries that were at the heart of that sovereign debt crisis ten years ago: Portugal, Italy, Greece and Spain.
Greece’s debt ratio is still a record
The interest rate turnaround is accompanied by the war in Ukraine, inflation concerns and fears of a new recession. The International Monetary Fund warns that this combination could develop dangerous dynamics. Above all, he sees risks in the developing countries. However, things are also getting uncomfortable for the highly indebted states of the eurozone, which have so far benefited from zero interest rates and the ECB’s bond-buying programs. The euro crisis began in Greece in 2009. At first glance, the country still seems to be in the worst position with the highest debt ratio: 193.3 percent of GDP at the end of 2021. In August 2021, the yield on the ten-year bond fell to 0.53 percent, its lowest level since the introduction of the euro . When Greece went public with a ten-year bond in mid-January, the country had to offer investors a premium of 1.84 percent. The yield on the ten-year paper is currently even 4.4 percent. Nevertheless, most analysts see no danger.
“Greek debt is sustainable,” says Klaus Regling, head of the Euro Stability Fund ESM, which is Greece’s largest creditor. The reason for the all-clear lies in the country’s debt structure: 75 percent of Greek government debt is held by public creditors such as the ESM and its predecessor, the EFSF. The interest rates on the aid loans are permanently low, and the terms run until 2070. The need for refinancing over the next few years is correspondingly low. In addition, Greece has a liquidity cushion of almost 40 billion euros. The strong growth is also depressing the debt ratio: “With real economic growth of seven percent compared to the previous year, Greece once again left the rest of the eurozone far behind in the first quarter of 2022,” says Holger Schmieding, chief economist at Berenberg Bank.
Political instability is looming in Italy
The EU Commission sees no immediate danger of a new debt crisis in Spain and Portugal either. The two former crisis countries have good growth prospects, not least thanks to the comeback in tourism and the funds from the EU Corona recovery plan. The focus this time is on Italy. This is mainly due to the sheer size of Italy’s mountain of debt. It accounts for nearly a quarter of the eurozone’s total government debt. The yield on the ten-year bond has risen from 0.56 percent to 4.1 percent since last August. The analysts are worried about the dwindling reform momentum in Italy and the prospect that Prime Minister Mario Draghi, who is regarded as a guarantor of stability, could lose his office in the elections early next year.
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A study by the investment bank Goldman Sachs warns that Italy is the country in the euro zone whose financial stability is “most threatened by political currents”. The refinancing costs in the more indebted Mediterranean countries are likely to increase significantly compared to the more solid northern states. The ECB could take countermeasures with new bond purchase programs. So far, however, the currency watchdogs in Frankfurt have not indicated how they intend to get this problem under control.
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