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Greece's financial woes spreading through Europe

German Chancellor Angela Merkel stands in front of European Union flag


Greece's fiscal crisis is rapidly spilling over to other parts of Europe, even hitting countries with relatively low debt levels.

Standard & Poor's Wednesday cut its credit rating for Spain, citing the country's weak economic outlook. The downgrade sparked concerns that the Greek-inspired debt crisis is spreading alarmingly fast and may soon infect other large, struggling eurozone countries, including Italy.

Increasingly, wary investors are dumping stocks and bonds in countries seen as risky. Spain's stock market dropped 3 per cent Wednesday amid a broader selloff in Europe. The cost of insuring Spanish bonds against default rose to more than 200 basis points, meaning it cost $200,000 (U.S.) to insure each $10-million of bonds.

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In the European Union, only the bonds of Portugal, Ireland and Greece have higher insurance costs. Italy's default insurance costs have also been rising, and the country was forced to pay higher rates in a bond auction this week.

The mounting concerns in financial markets have raised the spectre that a much larger, more expensive bailout plan will be needed to help Europe's worst-hit countries. Supporting Greece, Portugal, Ireland and Spain could cost the equivalent of 8 per cent of the gross domestic product of the other EU countries, or about €600-billion, said JP Morgan's chief European economist, David Mackie.

Although the EU and the International Monetary Fund are putting together a €45-billion bailout for Greece, the EU may need to quickly form a more comprehensive plan to contain the spreading financial crisis. The EU has to come up with a contingency plan in case the debt crisis begins to cripple weaker member countries, Mr. Mackie said. "It may now be time for the euro area to do something much more dramatic in order to prevent the stress from creating another broad-based financial crisis, which pushes the region back into recession."

German chancellor Angela Merkel came under intense pressure from the IMF and the European Central Bank to approve Germany's crucial funding of the Greek rescue package.

In response, Ms. Merkel on Wednesday said her government is prepared to pass the laws required to fund the bailout by late next week. "It's absolutely clear that negotiations by the Greek government with European Commission and the IMF now must accelerate," she said, alongside IMF managing director Dominique Strauss-Kahn. "This is about the stability of the euro overall, and we won't avoid this responsibility."

But she stressed that the onus was still on Greece to cut spending with "an ambitious program that can restore markets' trust in Greece."

Germany has been highly reluctant to deliver its share of the funds - estimated at €8.4-billion - because it thinks Greece is the author of its own misfortunes and should not, in effect, be rewarded for lax fiscal discipline and fudging its budget deficit figures. Germans also fear the Greek bailout tab will rise relentlessly.

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German parliamentarians said Greece would need between €100-billion and €120-billion in financial assistance over the next three years. The figures emerged after they met with Mr. Stauss-Kahn and ECB president Jean-Claude Trichet.

The implication was that the €45-billion on the table was for the first year only. If Greece were to receive €120-billion, it would mean the country would be shut out of the capital markets for three years running, making it a ward of the wealthier EU countries and the IMF.

Massive fiscal adjustments required by Greece, and probably Portugal and Spain, to stabilize their debt-to-GDP ratios are possible, but might take much longer than expected, based on previous EU debt-crunching efforts in the 1980s and 1990s, said Daniel Gros and Alcidi Cinzia, economists at the Centre for European Policy Studies.

Spain's debt downgrade pushed the euro, the currency used in 16 EU countries, below $1.32 (U.S.) for the first time in a year. While the Greek stock market rose slightly on the expectation that the rescue package would be approved next week, European indexes generally lost between 1 per cent and 2 per cent after a punishing sell-off on Tuesday.

Spain's benchmark index, down 3 per cent, lost the most ground. The country has announced austerity measures that some economists have dismissed as too little, too late. S&P said "additional measures are likely to be needed to underpin the government's fiscal consolidation strategy and planned program of structural reforms." S&P said it has a "negative" outlook on the country, meaning another downgrade is possible, though the double-A level it assigned to Spain keeps it investment-grade for now.

Still, the country is in better shape than either Portugal or Greece. Spain's new rating is eight notches above that of Greece, whose debt was downgraded to junk status on Tuesday, and four notches above Portugal's. Although Italian bonds have weakened, UniCredit Group economist Marco Annunziata said he does not expect a downgrade of Italy, whose deficit is a relatively constrained 5.3 per cent of GDP, one of the lowest in the EU.

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