What's next for the European Sovereign Debt Crisis

When people thought that the European sovereign debt crisis might had gone after European Union (EU) and International Monetary Fund (IMF) decided to rescue Greece and Ireland in 2010, the crisis has quietly reappeared this year.

Earlier on April 7, Portugal became the 3rd eurozone country to seek help from EU and IMF, after Moody's Investors Service downgraded its sovereign debt rating nearly to junk status.

On May 9, another rating agency S&P (Standard & Poor's) downgraded Greece's sovereign debt rating further below junk status. S&P also downgraded Italy's outlook from stable to negative on May 21 and continued to downgrade Greece's sovereign debt rating to CCC on June 13.

In mid June, EU announced not to pay the next quarterly installment of bailout, worth EUR 12 billion, to Greece if its parliament failed to approve the necessary austerity measures by the end of the month. On June 29 and 30, although there had violent street protests in Athens, Greece parliament eventually approved bills for a austerity plan which allowed EU and IMF to release the EUR 12 billion installment of bailout loans for the country.

The austerity bills that include pay cuts, tax rises and privatisation plan, however, could only prevent Greece from an immediate bankruptcy and got a reprieve of a few more months. The next installment of bailout loans for Greece will be necessary by September, at that moment Greece will need to corroborate it has completely delivered what it promised before the nation can get any further loans.

Just after Greece parliament approved bills for its austerity plan, when people thought they could put aside their worries for a while, S&P's made a harsh reminder to the market that Greece's debt rollover plan as proposed by France would still trigger a selective default (SD).

What's next for this never-ending European sovereign debt crisis? On July 5, Moody's Investors Service suddenly downgraded Portugal's sovereign debt rating to junk status on increasing risks for a 2nd bail-out. Moody's another concern is that Portugal is unlikely to achieve its deficit reduction target, from last year 9.1% to 3% by 2013 as requested by the EU/IMF program, owing to formidable challenges in restraining spending, increasing taxes, sustaining banking system as well as attaining economic growth. Portugal's Credit Default Swaps (CDS), as a result, then spiked to hit record high in the following days.

As Portugal has been downgraded, then will Spain, Ireland or Italy be the next? We believe the rating agency downgrades should have contagion effects in the euro-zone, and will also further add funding pressures on those countries already in troubles. They may later get into a situation that the austerity measures of these countries should hit economic growth to a level that they will not be able to meet their deficit reduction targets. It seems to be unavoidable that not just Greece but also the other European PIIGS countries will continue to seek more and more bailouts.

More financial related stories (in table form) can be found at our Financial Review 2011 Q2: Crisis Recurred. In particular, for Greece, you may read: Greece Debt Crisis is NOT over yet.