EU / Pushing Greece into recession

The Greek prime minister George Papandreou is embarking on a whirlwind tour of western capitals to drum up support for his crisis-stricken country. Papandreou's diplomatic offensive will determine whether Greece can secure help from its fellow eurozone members or whether the IMF will eventually be called in. What's at stake is no longer just Greece's creditworthiness, but also Europe's credibility.

The next fortnight is critical for the future of Greece and the fate of the eurozone. If Athens can raise about €22bn (£20bn) to pay off maturing debt in April and May, then the risk of a sovereign debt default spreading to other heavily indebted euro countries will subside. If not, then in the absence of a rescue operation from euroland, the Greek government would have no other option but to beg the IMF for help – further undermining the status of the euro as a credible alternative to the dollar.

Papandreou's mission comes about a month after a special EU summit in Brussels pledged collective European solidarity in exchange for tough Greek action. By announcing a third round of spending cuts and tax increases to reign in its budget deficit, Athens is fulfilling its part of the agreement. Now it's the turn of the eurozone to help Greece bring down the cost of borrowing – otherwise the economic reforms could lead to social unrest and bring down the Greek government.

This week's Greek bond issue was oversubscribed (bids worth €15bn for the available €5bn bond issue), but came at a high price. At 6.37%, Greece is paying more than twice as much in interest as Germany on a comparable 10-year bond. That is pushing up the cost of servicing existing debt – never mind new borrowing requirements in the second half of 2010 estimated at about €30bn.

By refusing to provide financial guarantees to state-owned banks buying Greek bonds which would help reduce the interest rate on Greek debt, Berlin is forcing Athens to devote more money to servicing debt and make even deeper cuts to public spending. This lethal mix is pushing Greece back into economic recession, reducing tax revenues, increasing the real value of its debt and requiring yet more savage cuts – a vicious spiral of debt-deflation that could plunge the country into an unprecedented social recession.

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