The Euro Area Sovereign Debt Crisis

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Citi Research analysts Giada Giani, Guillaume Menuet and Ebrahim Rahbari provide an update on the sovereign debt crisis in Europe.

The Euro Area Sovereign Debt Crisis

Spain and Portugal debt crisis

Spain and Portugal give the analysts some cause for concern. Portugal’s Deputy Prime Minister announced that if the country passes the eighth and ninth troika reviews of its economics, it would likely take recourse to a “precautionary credit line” when the current bailout expires. The action would be similar to that of Ireland’s request for a similar credit in 2014. The analysts point out, however, that Portugal’s economy is weaker than of Ireland and may instead require “a more full-fledged financial assistance from mid-2014 onwards.”

Spain’s deficit for the period Jan – July touches 5.27 percent of GDP, while the country faces a year-end target of 6.5 percent of GDP, which is achievable according to Spanish Finance Minister De Guindos. Citi feels, however, that there are some risks that the target may be missed. Spain took credible steps to contain pension expenditure by announcing new reforms that could yield savings of 3.3 percent of GDP during 2014-2022. Citi: The action will force negative real pension growth rates.

Cyprus debt crisis

The island country qualified for an IMF disbursement of 84.7M euros from the IMF following its “commendable progress in implementing near-term stabilization policies.” The IMF said the country was likely to meet its fiscal targets for 2013, though substantial risks remain.

Italy debt crisis

The country remains focused on the impeachment (or not) of Berlusconi by the Senate committee. Citi sees the chances of a compromise that may allow Berlusconi to remain in Parliament for a few more months. [At the time of writing the Senate committee vote went against Berlusconi, and its decision would need to be ratified by a vote of the full Senate next month.] “I will always be with you, at your side, expelled from parliament or not,” Berlusconi says in an emotional speech. There could be turmoil ahead if he withdraws support to PM Letta’s government. Meanwhile, Letta stuck to his guns and rebuffed calls for a withdrawal of a planned VAT rate hike, saying expected revenues had already been allocated to spending. Citi: Major spending cuts would need to kick in to rein in fiscal deficit to below 3 percent of GDP – not likely in 2013.

Germany debt crisis

Ulrich Grillo, head of UDI, the German industry association, called for clear and timely rules for sorting out unviable banks, with losses to be borne by owners, creditors, corporations and taxpayers in that priority. Citi notes that the German industry has been far more receptive to European initiatives in this regard compared to German banking. A separate report says interest costs, as a percentage of tax revenue, had risen to painful levels in some German regions, such as Bremen (33 percent), Saar (22 percent), Berlin (nearly 20 percent) and 15 percent in Northrhine-Westphalia. Citi expects Parliament to address the issue in the next term.

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