'No appetite to save the euro zone'

Tim Fox, the Emirates NBD chief economist, warns that the chances of a member nation defaulting is high and things could get 'very messy'. Rupert Wright reports.

Protest taxi driver throws stones against riot police during a demo in Thessaloniki on Saturday September 10, 2011. AP Photo/Dimitri Messinis

Greece now has the world's lowest sovereign debt credit rating.

Hardly surprising then that Tim Fox, the chief economist at Emirates NBD, has warned that the likelihood of the debt-laden euro-zone nation defaulting is "quite high".

"At the end of the summer it looked like Greece had been saved," he says. "But the situation has got worse. It is no longer a question of an orderly default. It might get very messy. Nobody seems to have the appetite or the ambition to save the euro zone."

German officials are openly talking about a plan B: how to save their country's bankers. The euro has stumbled from crisis to crisis, seemingly for the past 18 months, with European leaders struggling to grapple with the sovereign debt turmoil that threatens to bring down the single currency.

Portugal, Ireland, Italy, Greece and Spain precipitated the worries.

Greece, as part of the obligation of joining the euro, was supposed to have a budget deficit of 3 per cent of GDP, and a debt of less than 60 per cent of GDP. Last year's deficit was closer to 13 per cent and rising, while the debt is more like 150 per cent of GDP.

As rescue package after rescue package was hatched and dispatched, including €110 billion (Dh551.5bn) in May last year, the markets showed their displeasure by pushing up debt yields, in many cases doubling the cost of borrowing for these and other countries deemed at risk of default.

Only the euro itself remained immune, seemingly defying gravity by trading at closer to US$1.40 against a recommendation from the IMF that it should be valued at more like $1.20.

But that has dramatically changed. The European single currency has finally succumbed to downward pressure, trading yesterday at closer to $1.35, a seven-month low. Against the yen, it has hit a 10-year low, despite Japan's own problems after the tsunami and nuclear disasters.

This follows further divisions between European policymakers on the best way to deal with the situation.

Within Finland, reported to be asking for Greek islands as collateral, and Germany, there is a growing sense that Greece should default on its debt and leave the euro zone.

Others, particularly some among Portugal, Ireland, Italy, Greece and Spain, fear that if that were to happen, it would have a serious impact on their ability to stay in the single currency.

The are also other concerns. Major European economies, such as Germany, France and Britain, worry that a Greek debt default would have a catastrophic impact on their beleaguered banks, which lent a lot of money to the country in the hope that it would be repaid in euros.

q So, what happens now? Could Greece either be ejected from the euro or asked to leave?

a There is no specific mention in the Maastricht Treaty about how to leave the euro zone. One wag has described the single currency as being like the Hotel California as mentioned by the Eagles: "You can check out anytime you like, but you can never leave". In a sense, Greece has checked out, despite the best efforts of the prime minister, George Papandreou.

What about the German who checked out of the European Central Bank (ECB) at the end of last week?

Jürgen Stark, the ECB's chief economist, said he was leaving for "personal reasons", but some observers are reading into his departure that he was unwilling to support further bond buying by the ECB. Basically, the euro zone's debt crisis could be solved at a stroke if the ECB were to agree to buy as many bonds as sovereign countries wanted to issue. Just by saying it would do this, market players would see this as explicit support and buy the bonds themselves.

It is this kind of support that the US Federal Reserve has been showing. However, the Germans are very reluctant to do this. Mr Stark's departure has convinced many in the markets that the Germans no longer have the appetite to try to save Greece. "It feels like Germany is preparing itself for a debt default," Jacques Cailloux, the chief European economist at Royal Bank of Scotland, told Bloomberg News. "Fatigue is setting in. Germany could be a first mover or other countries could be preparing too."

Is that why bank shares are being hit this week?

Exactly. Bank shares are tanking as investors worry about the implications of a Greek default. In Germany, Deutsche Bank and Commerzbank were both down more than 8 per cent, while France's Société Générale and BNP Paribas slid over 10 per cent on Monday.

Could Greece pull it off?

Only with the support of its European partners and the IMF. Judging from the rhetoric coming out of Berlin and Frankfurt, German appetite to help is low. At the weekend, the Greek government announced it was imposing a two-year property tax to raise €2bn and plug a budget gap identified by the EU and the IMF. It's a start, but they need to do more if they are to convince lenders to hand over more cash.

Is a default such a bad thing? It's happened before surely?

Absolutely. Russia, Nigeria and Argentina have all defaulted on their international obligations. Public-sector creditors would convene via the Paris Club [an informal grouping of financial officials] while the private sector would meet at the London Club [a grouping of private creditors] - both are nominal organisations, not real clubs with addresses. There would then be an assessment of the country's debt situation. This would be followed by an agreement to write off some of the debt, and a restructuring or rescheduling to repay the remaining portion. Ironically, lenders are often willing to lend to countries after such an event because they have less liabilities.

But not in the euro zone?

Correct. That is the nub of the crisis. Nobody can be sure what effect one country leaving the euro would have on the other countries in the euro zone. There are 17 countries at present. If one were to leave, would it be like 16 green bottles "hanging on the wall, waiting to fall"?

But could Greece return to the drachma?

Possibly yes, although nobody knows how. But everyone would prefer, in the words of Timothy Geithner, the US Treasury secretary, that European authorities "demonstrate enough political will" to end the crisis. Instead the Dutch prime minister told the Financial Times last week that the EU should appoint a budget tsar with powers to dictate taxes and judge whether countries should be kicked out of the euro.

So will the Europeans finally get their acts together?

In two words, most unlikely.