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People walk by a banner in downtown Lisbon calling for a general strike on Nov. 24 in protest against government austerity measures. (Armando Franca)
People walk by a banner in downtown Lisbon calling for a general strike on Nov. 24 in protest against government austerity measures. (Armando Franca)

German bond proposal sparks unrest in EU's big debtors Add to ...

Germany's tough stance on bailouts for debt-swamped European countries has plunged weaker states like Ireland and Portugal deeper into turmoil, raising the threat of a return to national currencies for the very weakest economies.

Europe's debt crisis has spread in several directions, with Greece warning that Germany's proposals are driving the have-not economies toward bankruptcy, pressure mounting on Ireland to accept aid it insists it does not need, and Portugal's Foreign Affairs Minister warning the country could have to quit the euro zone.

Since last spring, when the debt crisis walloped the bond markets and pushed down the value of the euro, various economists have suggested it's only a matter of time before Greece and possibly other weak "peripheral" countries ditch the common currency and embrace their old money, which could be devalued.

A devalued currency is traditionally the quick route to making an economy more competitive. Devaluations, for example, can substantially boost exports. In the absence of devaluation, countries on the brink of financial collapse have to launch severe austerity programs, which can slow economic growth and trigger social unrest.

Greece's Prime Minister George Papandreou, speaking in Paris at a meeting of the Socialist International group, said Germany's plan to force private bond investors to share the cost of sovereign bailouts with taxpayers was responsible for creating "a spiral of higher interest rates for countries that seemed to be in a difficult position, such as Ireland and Portugal … It could force economies toward bankruptcy."

The German effort, promoted by Chancellor Angela Merkel, last week sent bond yields soaring in peripheral euro zone countries, notably Ireland, as short sellers hammered bond prices on the expectation that bondholders would face "haircuts" - potentially severe losses on their bond principal - in any sovereign debt restructuring.

The rising bond yields triggered a fresh debt crisis, six months after Greece accepted a €110-billion ($150-billion) bailout from the European Union and the International Monetary Fund. On Monday, Portuguese Finance Minister Fernando Teixeira dos Santos said Portugal might have to seek a bailout package if only to prevent other euro zone countries from getting infected.

"The risk is high because we are not facing only a national or country problem," he told the Financial Times. "It is the problems of Greece, Portugal and Ireland … This has to do with the euro zone and the stability of the euro zone, and that is why contagion in this framework is more likely."

The economic outlook for Portugal is so bleak that Foreign Affairs Minister Luis Amado said his country "faces a scenario of exit from the euro zone" - the 16 EU countries that share the euro - if it doesn't get its financial house in order.

"There has to be an effort by all political groups, by the institutions, to understand the gravity of the situation we're facing," he said in an interview published Saturday in the Portuguese weekly Expresso.

Portugal has emerged at the front line of the debt crisis even though its economy is expected to grow by 1.6 per cent this year, according to Deutsche Bank forecasts, and its budget deficit, at 7.5 per cent, is far less than Ireland's and Greece's. Still, Portugal has severe economic challenges, including an anemic growth rate, banks that depend on the European Central Bank for funding and a low private savings rate, meaning the country will struggle to fund itself over the long run.

In an interview, Jose Manuel Amor, a partner and strategist at AFI, a Madrid finance and economics consultancy, said Portugal is "likely" to seek assistance from the €440-billion European Financial Stability Facility (EFSF), which was set up by euro zone countries shortly after the Greek rescue to bail out other distressed countries.

"Even if the Portuguese situation is somewhat better than in Ireland, investors are seeing the same unsustainability," he said. "Also investors are shunning everything that could have a risk of restructuring."

Aware that the German proposal to force "haircuts" on private bond holders was driving up yields on the bonds of Ireland, Portugal and Greece, potentially pushing them off the economic cliff, the finance ministers of the biggest euro zone economies announced a partial reversal on Friday. Any bond restructuring mechanism would come into effect only after mid-2013 and would not apply retroactively, they said.

While that means holders of existing debt are safe, the statement did little to calm the debt markets. Yields on 10-year Irish bonds, which reached a record high of 9 per cent last week, dipped slightly below 8 per cent on Monday - a level that economists said was still high enough to shut the country out of the bond markets. In a note published Friday, UBS Investment Research said the probability of Ireland seeking a bailout "will continue to increase."

While the Irish government confirmed Sunday that it had had talks at the "official level with international colleagues," presumably a reference to the IMF, the European Central Bank and the European Commission, the country said it not seeking a bailout. Ireland does not need to tap the debt markets again until next July, suggesting it believes it has some time to stabilize its bonds. The country is scheduled to deliver a new budget on Dec. 7, one that is bound to include tougher austerity measures.

The yields on Portuguese bonds rose Monday over Friday's levels, as did those of Greek bonds. Greek yields climbed after the government forecast that its budget deficit in 2010 would reach 9.4 per cent of gross domestic product, breaching its 8.1-per-cent target. The new figure came after the EU's statistical agency, Eurostat, issued an upward revision of Greece's accounts for the past four years.

Eurostat said Greece's overall public debt stood at 126.8 per cent of GDP in 2009, the highest among EU countries. The previous figure, released in April, was 115.1 per cent.

Despite Greece's galloping debt and deficit figures, the Finance Minister said the government still aims to reduce its deficit to less than 3 per cent of GDP, the euro zone's limit, by 2014.

In a phone interview from Venice, Canadian Treasury Board president Stockwell Day, who was attending a public governance meeting with other ministers from the Organization for Economic Co-operation and Development, said the government was closely monitoring the European debt crisis. "When our neighbours [in Europe]do well, we do well," he said, referring to Canada's desire to have healthy trading partners.

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