EUROPE WEIGHS POSSIBILITY OF DEBT DEFAULT IN GREECE / THE NEW YORK TIMES ( VERY HIGHLY RECOMMENDED READING )

January 29, 2010

Europe Weighs Possibility of Debt Default in Greece

By STEPHEN CASTLE and MATTHEW SALTMARSH

European leaders are quietly considering whether to come to the aid of their troubled neighbor Greece amid fears that the nation might default on its debts and unleash another round of financial crisis.

Only a month after Dubai was rescued by its neighboring emirate Abu Dhabi, Germany, France and other European powers are discussing whether Greece might need a bailout too.

After a decade of debt-fueled profligacy, Greece is confronting what amounts to a run on the bank. And, despite repeated assurances from Athens, the nation’s strained finances have put already jittery financial markets on edge. On Thursday, the worries stretched all the way to Wall Street, where the stock market sank 1.1 percent.

Some economists worry that Greece’s troubles could have deep and lasting repercussions for Europe. The crisis poses complex challenges for the euro, which Greece adopted in 2001. The currency sank to a six-month low against the dollar and yen on Thursday.

“Greece failing is not an option, and lots of people think that we will have to intervene at some stage,” said one European finance official, who was not permitted to speak publicly on the matter. “It doesn’t have to happen, and we hope it won’t, but it would be better than seeing a default.”

The shape and scale of a bailout package, if any, has yet to be determined, according to officials in several European capitals. Whether the International Monetary Fund might become involved is uncertain. Some European leaders want Europe to fix this problem itself, while others are open to working with the I.M.F.

Publicly, neither Greece nor its European neighbors say a bailout is being considered.

“There is absolutely nothing to these rumors,” a German finance ministry spokeswoman, Jeanette Schwamberger, said in an e-mailed . “They are without any foundation.”

Prime Minister George Papandreou of Greece, speaking during the annual meeting of the World Economic Forum in Davos, Switzerland, said his country did not need a loan from the European Union. “We never asked for it,” Mr. Papandreou said.

But doubts have intensified over the credibility of the drastic austerity measures put forward to try to get Greece’s budget under control, in spite of concerted efforts by the Greek government to calm the markets.

Investors worry that the crisis in Greece could touch off a domino effect across Southern Europe. Many are fleeing bond markets in Portugal, Spain and Italy out of concern the troubles might spread.

The market’s judgment has been swift and brutal. On Thursday, the difference between the interest rates on Greek and German bonds — a measure of the risk investors perceive in the Greek debt — rose to nearly four full percentage points, its highest level since the euro was adopted.

Officials in Athens, Frankfurt and Brussels remained adamant that Greece was not at risk of being forced to abandon the euro.

As a condition of any aid package, the Greek government led by Mr. Papandreou would be asked to provide a more detailed program to bring the country’s deficit — currently equal to 12.7 percent of gross domestic product — under control. European Union rules call for a maximum of 3 percent. Officials insist that any bailout must not put into doubt the credibility of the euro.

Another condition of any aid would be further guarantees over the reliability of Greece’s economic data. Last year the newly elected government in Athens announced a sharp upward revision of its deficit figures, which have since been exposed as seriously flawed.

Next week, the European Commission is expected to propose greater powers for the European statistical agency, Eurostat, to audit the accounts of national governments.

The latest moves reflect a continuing skepticism among euro-zone members over the practicality of the plans put forward so far by the Greek government. Athens wants to reduce the deficit to 3 percent of G.D.P. by 2012, an objective described as unrealistic by one European diplomat, also speaking on condition of anonymity. These plans are also to be assessed by the commission next week.

Greece’s budget deficit is four times the E.U. limit, while the country’s debt amounts to 113 percent of G.D.P. But officials insist that, because Greece is not one of the euro zone’s larger economies, the problems created by its grim public finances can be absorbed. The Greek economy represents about 2.5 percent of the euro area’s G.D.P.

Richard McGuire, an analyst at RBC Capital Markets in London, said that dropping Greece from the euro zone would be far worse than any possible benefits that might be gained through readopting the drachma and devaluing the currency to seek improvements in competitiveness.

For Greece’s neighbors, there is the possibility of a domino effect, with investors subsequently moving on to test the resilience of another heavily indebted member of the euro area — possibly Italy, whose debt is also 113 percent of its gross domestic product.

“Allowing the fiscal shortcomings of what is a small corner of the region to prompt a spike in debt servicing costs of its larger peripheral peers makes little sense,” Mr. McGuire said.

The mechanism of any E.U.-sponsored bailout would be complex, since there is doubt as to whether it is permitted under the union’s governing treaty.

One option, deemed unlikely, would be issuing a sovereign bond for the entire 16-nation euro area. That would probably require complex legal changes among members.

Nevertheless, the Socialist leader in the European Parliament, Martin Schulz, called on the commission on Thursday to bring forward proposals to introduce the bonds.

“Now is the time for us to stand shoulder-to-shoulder with Greece — not to abandon the country to the mercy of world markets,” he said.

A number of possible proposals are under discussion, and the talks are likely to intensify ahead of an European Union summit meeting on Feb. 11 in Brussels.

On Monday, Greece paid a hefty 6.22 percent rate to borrow money in the bond market, underscoring investors’ concern.

In an interview this week, the Greek finance minister, George Papaconstantinou, acknowledged that the high rates were punitive but asked that investors keep faith. Greece needs to raise at least 53 billion euros this year, much of it this spring.

Landon Thomas Jr. contributed reporting.

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