South Eurozone countries threatened by rising borrowing cost and expensive euro

Angela Merkel, German Federal Chancellor, Mario Monti, Italian Prime Minister and Minister for Economy and Finance ad interim, and José Manuel Barroso, President of the European Commission (from right to left). (EC Audiovisual Services).

Angela Merkel, German Federal Chancellor, Mario Monti, Italian Prime Minister and Minister for Economy and Finance ad interim, and José Manuel Barroso, President of the European Commission (from right to left). (EC Audiovisual Services).

A strange combination of the expensive euro (undermining external competitiveness) and worsening market conditions for sovereign borrowing by south European countries, are increasing the pressures on the four crisis stricken Eurozone member states, Greece, Spain, Portugal and Italy. In this way the positive developments of dropping risk premiums that prevailed since the beginning of the year on south European debt, turned yesterday to the negative area, with investors demanding now larger yields for their placements on such debt. Let’s take one thing at a time.

It seems that what changed this week is the political scenery in Italy and Spain. With the Italian elections approaching, Silvio Berlusconi is seen every-day more and more aggressive promising greener grass. This past weekend he didn’t hesitate to promise reductions of a large number of taxes and even said he will increase salaries in the public sector in their pre-crisis levels, if elected. He says he will get the money by taxing the rich.

In Spain the political horizon is also darkened with the personal problems of Prime Minister Mariano Rajoy, after the allegations that he was illegally receiving payments from his party coffers, while in opposition. Of course Rajoy denied everything. However the negative climate in the country against all main stream politicians and the widely held view about uncontrollable political corruption, have turned the public opinion against the government. The leader of major opposition socialist party actually asked the Prime Minister to step down. Rajoy rejected any talk about resignation, speaking from Berlin where he is on two-day official visit.

Dearer borrowing

In such a climate in the two heavyweights of South Europe, the financial markets started having again second thoughts about risks. Naturally the borrowing cost in the two smaller countries was dragged upwards just by contagion. And all that despite the fact that Greece announced a primary surplus in the government budget exercise for 2012, for the first time after many decades. On the other corner of South Europe, Portugal doesn’t seem to encounter any major political problems in applying a multi-year austerity plan, but again here too borrowing cost has increased.

It was very interesting to watch yesterday in all and every European market the pressures on the region’s sovereign debt paper, leading to higher risk premiums across the board. The question is however if this tendency will gain more momentum or investors will stop and wait for the Italian elections results and the Spanish government problems to subside.

More probably however investors will continue watching the public opinion pools in Italy as well as the way Rajoy manages his personal problem. If Berlusconi increases his attraction to voters, borrowing cost will continue on the current upward course. In short if the Italians want more Berlusconi, they have to pay dearly for him.

Tourism will suffer

Apart this discouraging political outlook in the European South,  the four south-most Eurozone members states have to cope with another negative prospect, which may last much longer than the political difficulties; the expensive euro. The single European money has being continuously appreciating from the beginning of this year.

Given that all four South Eurozone countries depend heavily on summer season tourist incomes from third country visitors, the expensive euro is cutting down their prospects for an exit from the recession, they are all in. If it was not for the political uncertainties in North Africa and the Middle East, the expensive euro could have ruined the season for the entire south European tourist industry. Even holidaymakers from the other Eurozone countries could choose North Africa this summer for their vacations, using the advantage of their high value currency to get good deals outside the single money zone.

The EU’s South however cannot count on the security risks of other to boost its prospects. Berlin has to do what it takes to keep the euro parities at reasonable levels. And this is neither difficult nor unpopular. Germany’s political and business leadership must simply accept, that the millions of their working compatriots deserve better pay. In this way the euro will become a softer money and the rest of Eurozone will gain from a stronger demand for goods and services.

 

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