Debt Crisis May Endanger Europe's Economic Recovery

In the third quarter of 2009, the Euro Area economy emerged from the worst recession since World War II. Yet, during the last few weeks, the single currency union has been facing the biggest challenge since its establishments as lower tax revenues started bringing fiscal deficit in some member countries to unsustainable levels.

Indeed, the aftermath of the recent economic downturn, has finally unveiled how weak public finance of many Euro Zone members have been. In fact, looking back, lower interest rates which came with Euro Area membership not only have allowed many countries to refinance its debt but also encouraged them to borrow and spend more. For example, from 2000 to 2008, Greece current account deficit rose more than nine times, in Spain quadruped and in Portugal more than doubled. Looking further, Greece and Portugal free from exposure to toxic assets,protected by euro membership and low borrowing cost managed to weather global financial crisis pretty well. Yet, even the small economic contraction has ceased consumption and reduced tax revenues more than expected, bringing public finances to unsustainable levels.

Someone may ask why to worry so much about default if Greece, Portugal and Ireland combined, account only for 6% of Euro Area GDP? In fact, there is reason for concern because a public finance crisis may easily spread in Europe as investors may consider other European countries bonds risky and ask for higher interest payments. More importantly, Greece default on its debt may trigger a domino effect as many Euro Zone economies with weak public finances relay on foreign yields as a source of revenue.

Anna Fedec,
2/6/2010 12:24:28 PM