Unlike companies that can and often do go bankrupt and then disappear, countries may become insolvent but they continue to exist. In the current debt-driven global meltdown, Iceland was the first economy to collapse under the weight of unsustainable debt, largely from its banking sector.
Now the people of Ireland, once known as the “European Tiger” are having to endure the same drastic governmental cuts to their services together with the tax hikes that Icelanders are already experiencing. These two countries are unlikely to be the last.
Eurozone member Greece has just seen its international debt rating cut and received a stern warning from the European Central Bank (ECB) that unless it orders its finances within a year, its government bonds will not be accepted by the ECB as collateral for Greek bank borrowings. This would have the effect of paralyzing Greece’s finances. With continuing public unrest stoked by far left militants, implementing the sort of structural reforms to its addled economy is a high-risk proposition for the socialist government of Premier George Papandreou. The problem for Greece is that its finances have long been a Byzantine mess, with widespread tax evasion and vast payouts of government cash to sustain loss-making state-run industries and keep their bloated and militant work forces quiescent.
There are those in Brussels who always thought Athens’ assurances it would mend its financial ways should never have been accepted and the country therefore should not have been allowed to become part of the eurozone. Efficient and ordered economies such as those of Germany and France now share a common currency with an economically incoherent near basket case like Greece. The ECB knows what needs to be done but if past Greek governments failed to undertake radical financial reform in good times, what is the likelihood of a left-wing premier grasping the nettle in the current global crisis? Greece could once again dissolve into civil unrest. Then what will Brussels do?
For international investors the reality of sovereign risk has always been there. Government bonds are priced according to the extent of the perceived risk. Dubai’s current woes have heightened the perception of risk in capital markets. It was inevitable that the spotlight would fall on Greece. The beam seems certain to widen. Fellow eurozone countries Portugal and Belgium are struggling. Within the EU but outside the euro, the UK has plunged into debt and recession and Hungary is not alone among East European countries to be struggling with unmanageable debts. Despite its oil wealth, Russia is in serious economic difficulties. Analysts are even starting to question the financial viability of the US economy, sustained as it is on trillions of dollars of Treasury bill purchases, principally by China and Japan.
As economies begin to look shaky, countries are forced to pay more to borrow in the international markets, which in turn compounds their problems. Investors, of course, enjoy earning more but all are now wary of the ultimate risk of a single sovereign default — let alone the multiple country failures that some analysts now fear.
