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Workers chant slogans during a protest in central Athens on Thursday, Dec. 17, 2009 (Petros Giannakouris)
Workers chant slogans during a protest in central Athens on Thursday, Dec. 17, 2009 (Petros Giannakouris)

Greece, Austria and PIIGS: Europe's risks Add to ...

Whether Europe's most troubled economies have the political will to tackle record deficits will preoccupy investors in Western Europe in 2010, along with Britain's election and potential overspill from emerging market crises.

Meanwhile, the continent could face a rising risk of social unrest as well as ongoing government intervention in the private sector, both legacies of the economic crisis.

Deficits, austerity measures and 'PIIGS'

Greece's attempt to reassure markets while placating its own populace and cutting government expenditures looks to be an early example of what will be a key theme of Western European politics this year as economies wind down stimulus packages and aim for austerity.

The euro zone's weakest economies - the so-called PIIGS of Portugal, Italy, Ireland, Greece and Spain - look to be most under the hammer, although each approaches the crisis in different ways. Trouble in one could affect sentiment towards the wider euro zone. Ireland has been praised for its brutal cuts, while Greece is out on a limb.

What to watch :

- Do bond markets continued to pressure the PIIGS?

- Is Greece forced to announce a new round of austerity measures to regain market confidence?

- Credit ratings moves. In the absence of any other external arbiter such as the IMF or World Bank, the agencies have acquired much greater importance and look to be on a collision course with Spain and Portugal as well as Greece

--Comments from German or other EU policymakers on potential support for peripheral states in the event of a crisis. Markets broadly assume an "implied guarantee" but would need reinsurance in the event of a market slump

- Is there any political backlash against central banks as they begin to withdraw billions of dollars in stimulus support?

British election

British Prime Minister Gordon Brown must call elections before June 2010, with the prospect of political instability and policy uncertainty already unnerving markets, particularly sterling. With Britain's credit rating potentially under pressure if it does not address its own budget deficit, markets still want more policy clarity from the presumed victors, Conservative party leader David Cameron and Shadow Chancellor George Osborne.

But opinion polls show the Conservative lead over Labour narrowing, raising the prospect of either a hung parliament with no one in overall control or a small minority of either side that could make governing all but impossible.

What to watch :

- When does the election come? Most predict early May, but the narrowing poll gap has prompted media speculation of an earlier poll.

- Does the poll lead continue to narrow? If it does, markets will have to factor in a greater chance of a hung parliament and that could hit the pound.

- Does the economy recover? Mr. Brown will be hoping for a visibly recovering economy to boost his reelection chances.

- Post-election ratings action. Ratings agencies look unlikely to move before, but could take swift measures after if they do not believe the deficit is coming under control.

Unrest and populism

High unemployment coupled with almost continent-wide public spending cuts - as well ongoing economy measures at private firms - look likely to boost social and industrial unrest, particularly in Western Europe, where austerity measures will generally begin in 2010.

Greek communists have already called strikes in protest against the government's latest cuts, while British Airways is only the latest private company to be battling threatened strike action.

Nevertheless, social unrest in emerging Europe - which had to make the cuts much earlier to conform to IMF and EU bailout conditions - has risen less sharply than many predicted. More likely than widespread chaos is that governments will be keen to take popular steps to stem discontent - for example, by targeting bankers' bonuses.

What to watch :

- What happens to unrest in Greece. So far, recent protests have been well below the level of widespread riots last year. A bellwether for other countries?

- Heightened industrial unrest in Britain both in the runup to elections and also particularly after any transition to a Conservative administration.

Intervention in the private sector

Austria's nationalization of Hypo Group Alpe Adria - reportedly for fear its collapse might spark a "Lehman effect" in emerging Europe - is a reminder state intervention in the private sector remains high.

France, Britain, Greece and others have tapped into public anger to tax bankers bonuses despite warnings it would undermine their financial sectors.

Possibly mindful of marginal constituencies in the British Midlands ahead of next year's election, Business Secretary Peter Mandelson has weighed into the potential takeover or job firm Cadbury by U.S. giant Kraft, arguing the state-funded Royal Bank of Scotland should not be backing the purchase.

What to watch :

- A likely increase in rhetoric from policymakers across a range of private sector industries.

- Are "one-off" taxes against banks repeated, and are there any signs of financiers fleeing London and Paris for other centres?

Emerging overspill

Nearby emerging markets offer a range of risks that could easily spill over into Western Europe, with the risk of further defaults or restructuring from Ukraine and Dubai top of the list, both essentially political decisions by ruling elites.

But several faltering IMF deals in Eastern Europe - potentially undermined further by upcoming elections - could also spark crises that could hurt European banks and potentially even drag down the euro.

What to watch :

- How much support did Dubai get from fellow emirate Abu Dhabi?

- Does Ukraine's Jan. 17 presidential election lead to more political stability, or are parliamentary elections going to prolong paralysis well into next year?

- Does Latvia's government collapse in the runup to October parliamentary elections, potentially prompting a new crisis and threatening the currency peg?

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