The recession Europe has to have: Maley

Global financial markets look set for an agitated week as they wait to see whether a compromise agreement for bailing out Greece can be hammered out ahead of a critical meeting of European Union heads of government on Thursday and Friday.

Continued German opposition to footing the bill for a Greek bailout makes it likely the International Monetary Fund will be involved. According to the French newspaper, Le Monde, IMF chief, Dominique Strauss-Kahn has told EU officials that the IMF is ready to help Greece, but the organisation could only lend the country between $US13.5 and $US16.2 billion.

Many believe Greece will need to announce a loan package of about $US75 billion – covering the Greek government’s entire borrowing needs this year – in order to soothe financial markets. As a result, eurozone countries will still be called on to provide bilateral loans or guarantees to Athens.

Ahead of this week’s meeting, European Union leaders are anxious that the Greek fire might spread throughout the region. The euro was hit last week by fears of Greece’s debt problems, falling almost 2% against the greenback and the yen, and even losing ground against embattled sterling. It also plumbed a record low against the Swiss franc.

The fire was fanned by comments from Greece’s Prime Minister, George Papandreou, who threatened the country would turn to the IMF unless the eurozone was able to commit to package of loans or guarantees that would restore confidence, and allow Greece to borrow at lower interest rates.

Papandreou is complaining that Greece has made savage cuts on government spending, but risks losing much of the benefit of these spending cuts because Athens now has to pay a much higher interest rate bill. He argues that Greece urgently needs to cut the interest rate it pays on the $75 billion of debt it needs to raise this year, including about $30 billion in the next two months. Earlier this month, Greece had to pay an interest rate of 6.4% when it raised $6.8 billion in 10-year bonds.

In contrast, the IMF would likely charge 1.25% on the first $7.5 billion Greece borrows, then 3.25% on any extra debt.

But the issue of the IMF financial support for Greece has highlighted the sharp north-south divide in the European Union. Germany, the Netherlands, the United Kingdom and Sweden favour calling in the IMF. But others, particularly those in the core eurozone area, including France – are less enthusiastic.

Last week, French Finance Minister Christine Lagarde ruffled feathers in Berlin by attacking Germany’s trade surplus in a newspaper interview. She followed this up with an interview on French radio in which she suggested that Germany could cut taxes to stimulate consumer spending.

German Chancellor Angela Merkel fought back, telling German parliament that Germany would not give up its strengths. Instead she argued that countries that continually flouted budget rules should be expelled from the eurozone.

At the heart of the divide is the difference in economic performance between the two regions. As a result of joining the euro zone, the PIIGS – Portugal, Italy, Ireland, Greece and Spain – had access to cheap funding. As a result, these countries ramped up their borrowings, and spending.

But they now face a prolonged period of austerity. To comply with eurozone rules, Greece will have to cut its budget deficit by 10% of GDP over the next three years, Spain by 8%, and Portugal by 6%. This massive contraction in government spending will likely plunge their economies into a deep recession.

This article first appeared on Business Spectator.