The downgrading of Greece's sovereign debt to junk status is not a big surprise as the country's financial position has looked increasingly precarious and unsustainable for some time. However, the nervous reaction from the financial markets begins to focus the mounting pressure on a number of eurozone countries whose debt profiles are also of concern.

The problems of Greek debt are clearly evident with debt to GDP at over 120 per cent and a public sector deficit of 12.7 per cent of GDP in 2009. Portugal, which also saw its credit rating downgraded but remains at investment grade, has debt to GDP of 90 per cent and a deficit of 9.4 per cent in 2009.

The big fear for the market is that of contagion risk, with sovereign problems for Greece quickly spilling over to other vulnerable euro countries, such as Portugal and Spain, and then placing pressure on the whole eurozone. A wide sovereign debt crisis certainly has the potential to derail the global economic recovery. However, the most vulnerable region is clearly Europe and without a clear package and implementation of a support programme, then at the worst the euro could unravel. The euro has already dipped to its lowest level for a year but more weakness is likely to occur.

For a eurozone country, Greece's bonds are yielding 10 per cent for 10-year bonds and for two-year debt the country is paying 15 per cent.

These are extraordinary high interest rates for a euro member and show the lack of confidence in Europe's efforts so far to shore up the problems which Greece is facing. Portugal's 10-year debt is yielding 5.6 per cent, still high for an investment graded European country. The yields are far higher than many emerging markets.

The Greek Government has asked for implementation of a joint European Union-IMF bailout package, the first time that a eurozone member country has had to avail itself of outside help in the 11-year history of the currency. The resistance from Germany, combined with growing market fears over whether Greece can service its debt, is causing significant market fear.

There are many worries about Greece's mounting debt with increasing doubts about its ability to pay off its debt. The high cost of borrowing for Greece exacerbates the problem. Europe has made much noise about supporting Greece through a financial support package but so far this has come to little. Greece is in desperate need of a European-managed multi-billion euro bailout as the country needs the money soon to pay off imminent debt becoming due as it cannot now access the markets.

Adding to Greece's problems is a weakening economy which is further eroding the market's confidence in both Greece and Europe dealing with the country's fiscal position. Greece has requested the European Union and the IMF to activate a three-year rescue package worth $65 billion (Dh238.68bn) in the first year. Leading euro countries such as Germany are demanding that Greece first put in place tough fiscal and monetary actions which are needed. The Greek Government itself is facing pressure from the public fearful of dramatic cuts which are needed. Even if the loan is provided, it may not resolve totally Greece's debt problems as further funding may be needed.

The main challenge for Europe is the contagion impact on eurozone members as other highly indebted countries would be caught up in the financial turbulence.

A co-ordinated and quick financial rescue plan by the European Central Bank would seem unlikely as members are to now only supportive verbally for a substantial rescue package. It will be no easy feat and any faint impression of hesitation or uncertainty of success would quickly cause a crisis for Europe.

Banks in Greece will also come under further pressure as a result of the sovereign downgrade. Again, if contagion spreads in Europe, then European banks will also experience an impact. In turn, this would potentially have a further negative impact on businesses and consumers with little supply of much needed credit and, combined with weaker economic growth, bad debts could rise again.

The next few months will be crucial for both Greece and the eurozone. Without a coherent and effective rescue, sovereign risk will spread and the euro will come under further pressure.

 

- The author is a US-based commentator on business issues