EU: Eurozone will not break up due to crisis

20th January 2009, Comments 0 comments

The eurozone's detractors have long argued that the bloc would not be able to hold together if the divergence between the interest euro governments pay on their debt grows too large.

Brussels -- The death of the eurozone has been grossly exaggerated despite growing strains in the bond markets, where governments plan to raise the trillions needed to pay for their economic recovery plans, a top EU official insisted on Monday.

The spread between interest rates on debt issued by high-deficit eurozone countries compared to low-risk German government bonds widened last week to the highest levels since the eurozone was formed in 1999.

The eurozone's detractors have long argued that the bloc would not be able to hold together if the divergence between the interest euro governments pay on their debt grows too large.

EU Economic and Monetary Affairs Joaquin Almunia on Monday insisted that the move in the markets was not an ominous sign that the shared-currency bloc would break apart.

"I am not worried at all by those who have announced for 10 years in a row that the euro area will split. Honestly, I don't think that this is a real hypothesis," he told reporters in Brussels.

"It is normal that the market assess the risks. So the existence of a spread in euro area government bonds is logical because not all members of the euro area have the same fiscal position over the medium- to long-term," he said.

The commission updated its economic forecasts on Monday, estimating that the combined public deficit of the eurozone would balloon from 1.7 percent of output to 4.0 percent in 2009 and 4.4 percent in 2010 as governments spend more to try and get the economy moving again.

However, the overall figure masked a much more dire situation, with Ireland's deficit, for example, expected to swell to a stunning 13 percent in 2010 and Spain's hitting 5.7 percent the same year.

The spread between low-risk German government bonds and debt issued by Greece, Ireland, Portugal and Spain widened recently after ratings agency Standard and Poor's cut Greece's rating and warned of a downgrade for the other three countries.

By coincidence, S and P reduced its rating on Spanish debt on Monday as Almunia spoke, cutting it to AA-plus from a coveted AAA level -- the highest possible and indicating virtually there is no risk of default.

Almunia, himself a Spaniard, said that while the risk of default could never be ruled out, it was next to non-existent for any euro area country.

"In the case of the euro I don't think that the risks (of default) are high," he said as he presented a forecast for the eurozone economy to contract by 1.9 percent this year.

"Those who have not consolidated their public finances in due time, in good times ... should pay higher spreads. This is an element of market discipline," he said.

Likewise, analyst Ben May at consultants Capital Economics warned that although market talk of default looked "overblown," spreads would only keep widening unless governments convincingly tackle their deficits.

"But looking ahead, a prolonged economic contraction, rising government debt and relatively high government borrowing costs will only raise such concerns (about default) and could even trigger calls for some of these economies to leave the single currency," he warned.

In light of the growing divergence in government bond spreads, Dutch Finance Minister Wouter Bos said that he expected his eurozone counterparts would be discussing the issue.

"We should not only look into ways to stimulate the economy but how to pay the bill and ... make sure that we move back to sustainable paths for government finances," he said as he arrived for a meeting with his colleagues in Brussels.

With government bond spreads growing, Almunia acknowledged that the idea of common issuance of debt by eurozone governments had been revived, along with proposals for group's of euro countries to issue a bond together and some kind of multilateral guarantee of debt raised by euro members.

However, he insisted that although such ideas have been around at least since the eurozone was formed in 1999, the talks were only in the early stages.


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