The crisis in Europe was sparked by the widespread belief among
investors that Greece's financial woes were just the tip of a much
bigger debt iceberg in the Eurozone. The fear has been that other
member nations – Portugal, Ireland, Italy and Spain, which, along
with Greece, are called the PIIGS – were also buried in debt and
could tip over into crisis just as Greece has done.
But is that really the case? Are all the PIIGS in the same hot
water as Greece? Barclays Capital economists ran some figures in a
recent report analyzing the chances that the various PIIGS would
fall into Greek-like debt meltdowns. What did the findings
show?
Though the other PIIGS are better off than desperate Greece,
most of them unfortunately are very, very vulnerable.
Barclays looked not just at the solvency position of the PIIGS'
governments, but also the severity of the fiscal adjustment
necessary, the total financing needs of the state, the strength of
the banking sector, and the level of dependence on foreign sources
of financing. Then the bank awarded each PIIG a “score” measuring
its vulnerability to insolvency. Needless to say, Greece's score
was the worst, but surprisingly, most of the rest of the PIIGS
posted scores remarkably similar. Portugal came in an uncomfortably
close second with a score of 4.3 versus Greece's 4.5. In third
place was Ireland, at 4.1. Spain followed at 3.4. I was struck by
Ireland's ranking here, since the financial markets seem to
indicate greater confidence in Ireland than the other PIIGS.
Ireland's score got hit because Barclays figures it has the most
troubled financial sector.
The only country that Barclays questioned should be a PIIG is
Italy, with a much lower score of 2.1. Here's why:
Italy does not really belong to the group. It has been included
based on its high initial debt-to-GDP ratio. However, when
accounting for the fiscal dynamics (ie, the very low primary
deficit), the potential financing needs (ie, the larger domestic
creditor base) and the comparatively modest risk in the banking
sector (in particular, the low real estate related risks), it
becomes clear that Italy is not in the same risk category.
How did
Europe's giant 750 billion euro ($950
billion) rescue fund announced this week change the
picture? Quite a bit, Barclays says. The folks at the EU obviously
did a good job on the math:
The EUR750bn more or less matches the combined gross financing
needs of Greece, Portugal, Ireland and Spain for three full years.
Therefore, it would allow for the replication of Greek-like
packages, allowing these countries, in principle, to remain out of
the market for two to three years. This would seem to substantially
reduce the immediate threat of financing crises.
Barclays says that, with the crisis package in place, now
investors will be closely watching the incredibly drastic fiscal
adjustments the PIIGS need to make:
Going forward this is likely to shift the market's attention to
the actual implementation of announced fiscal measures and also to
growth performance as these measures are being implemented. The
risk is that if these developments surprise on the downside,
markets' enthusiasm for the EU's mega package may not last.
My guess is that investor sentiment will almost definitely turn
on this fiscal reform issue, despite the big bailout fund. I don't
see that it's possible for all of the PIIGS to undertake the fiscal
measures necessary. Especially Greece. Barclays figures that Greece
must completely reverse its fiscal position, from a primary deficit
of 8.5% of GDP in 2009 to a surplus of at least 5% by 2014 in order
to ensure solvency. Such a turnaround just seems ridiculous. That's
why widespread fears remain that Greece will eventually need its
debt restructured to lessen the burden on its feeble finances, no
matter what bailout packages might be put in place by the EU. If
that happens, creditors will take a hit, and we could end up
rebooting the debt crisis.
So Barclays sums up on a sour note. Aside from Italy, the other
PIIGS are in a bad enough financial position to keep investors
nervous, and thus crises likely.
Most of the other countries studied, however, would seem
sufficiently fragile for a potential solvency crisis to become
self-fulfilling, in our view, especially if investors price in
higher default probabilities, raising the countries' financing
costs.
In other words, Europe's debt crisis, which now seems to have
abated, could roar back again at any moment. Yikes.