Europe is not out of woods yet

On the face of it, the apparent agreement of the sixteen euro zone member countries to provide Greece with a $145 billion (Dh532bn) bailout loan would suggest that both the debt problems of Greece and the pressure on the euro would be over. However, far from providing an impenetrable support package for Greece, there are still many doubts and challenges remaining for the indebted country. Moreover, the debt positions at a number of other euro zone countries, including Portugal and Spain, remain vulnerable.

The biggest problem facing Greece is that the demands placed on the country for winning the loan look completely unachievable and unrealistic. The austerity plan for Greece sees budget cuts of €30 billion (Dh140.5bn) over three years, reducing the country's public deficit to below three per cent of the GDP against the current level, which is approaching 14 per cent. The level and pace of budget cuts would test any country, let alone Greece, where workers' unions remain powerful. Other public sector cuts and tax increases are part of the programme, but the ability of the Greek government to achieve the objectives is minimal at best.

The markets are starting to realise this and thus doubt on the whole basis of the rescue package is emerging. In turn, the focus on Greece's immediate and long-term debt problems is increasing. Moreover, if the expected expenditure reductions and revenue raising is not achieved, then the loan received from the euro states as well as the IMF will not be enough for Greece. The situation is exacerbated by the fact that the country will see a severe recession this year and another difficult year next. Interest rates for Greece bonds remain very high and hence expensive.

The sovereign contagion risk is far from having played out. In fact, the opposite has occurred as with doubt growing on the whole rescue package and strategy for Greece, investors, traders and bond holders have refocused their attention on other euro member states with weak fiscal positions.

The euro, already at its lowest level for some time, looks set to test further lows and could approach the 1.25 to the dollar mark over the next few months.

The current crisis in the euro zone will likely halt the expansion of new members joining the euro. Countries such as the three Baltic states, and central and eastern European countries including Hungary, Poland and Romania, have applied to join the euro zone but the door may now be closed, perhaps permanently. In fact, the enlargement of the European Union may be difficult going forward, and it looks increasingly unlikely that countries such as Turkey would be allowed to join due to the issues raised through Greece's situation. Previously, the belief was that the larger the euro zone, the more safety and certainty was provided for all member states. This is no longer the case.

European Monetary Union member states must abide by low-inflation, low-deficit criteria both before and after joining the euro. As has been seen, not all countries have followed this script. Moreover, countries are able to manipulate economic statistics, providing a rosier economic picture than reality.

The problems in Greece highlight how difficult it is to manage a common currency for such a wide and different group of countries with vastly dissimilar economic profiles. Through the rescue package provided to Greece, the European Central Bank has relaxed lending rules for member states, and has also diluted other supposedly stringent rules. This move creates unease and also erodes confidence in the strength and stability of the currency. This is playing out in both the bond and currency market of the euro. Yields on the high risk member states have soared while prices of bonds on the stronger countries have also fallen.

Economic and debt problems in Greece and other weaker European countries will also dampen economic growth throughout the EU. Market liquidity will also remain tight to the extent that, together with economic growth pressure, the ECB may be forced to provide quantitative easing. Led by Germany, this move would be resisted by the stronger EU countries but if countries such as Portugal and Spain get caught in Greece's debt hurricane, there may be no other option.

Despite the substantial rescue loan for Greece largely in place, the country is still deeply in trouble and problems and challenges are increasing for Europe and the euro.

- The writer is US-based commentator on business issues. The views expressed are his own