Eurozone Crisis

            As the threat of a global slowdown hangs like the Sword of Damocles over the world, major European economies like Spain, Italy and recently France are becoming affected by the European debt crisis. It is a cause for concern given that these countries are major economies, with Spain and Italy alone accounting for 29% of Eurozone economic activity. Italy and Spain are Europe’s 3^rd and 4^th largest economies respectively, and are too expensive to rescue through Europe’s bailout fund, having over a third of Europe’s public debt.

       Both Italian and Spanish ten-year bond yields jumped to highs of more than 6% (reflecting plummeting prices), and hence a sharp rise in Italy’s implied borrowing costs. This 6% is too close for comfort to the 7% level beyond which investors become reluctant to fund sovereign borrowers The rising borrowing rates have also sent ripples through both nations political leadership, with Italian Finance Minister Giulio Tremonti calling an emergency meeting to analyze the situation and Spanish Prime Minister Jose Luis Rodriguez Zapatero postponed the start of his near three-week summer vacation to keep abreast of economic developments.

      Three major problems plaguing Italy include a problematic political climate, a forecast of sluggish growth for 2011-2012 and the rising borrowing rates. In particular, investor confidence has been shaken by conflicts of interest, sex scandals and doubts about the credibility of the Italian leadership. Low growth, around 0.1% in the start of 2011, is also a problem. Moody's has an Aa2 rating for Italy and Fitch an AA-, while Standard and Poors has assigned an ‘A+' long-term and 'A-1+' short-term sovereign credit ratings on Italy.

        Spain has issues of its own, with the banking sector remaining in turmoil, skyrocketing unemployment rates and high debt. The unemployment rate has nearly touched 20%, and meager growth has not helped matters. Although Spain found buyers for €661m (£581m) of 18-month bonds, it had to agree to pay a yield, or interest rate, of 3.912%. This is the highest yield on such bonds since 2002 and a significant rise on the 3.26% agreed at the last sale of 18-month bills. Credit rating agencies are taking a negative outlook, with Moody's Aa2 rating for Spain is in line with S&P's AA setting, and Fitch has the country one notch higher at AA+

            The focus of the Eurozone crisis has also recently shifted to France, Europe’s number two economy, with the country’s AAA credit rating under scrutiny. These jitters have translated into panic selling of French bank shares and an abrupt halt to economic growth has merely added to France’s woes. The French government in response has pledged fresh tax rises, spending cuts and other budget measures to help control the situation.

            On August 12^th, 2011, four Eurozone countries – France, Italy, Spain and Belgium have temporarily banned short-selling of financial shares in an attempt to restore order to the markets. Also, the European Central Bank has recently said it would buy bonds from Italy and Spain following emergency talks on the debt crisis. Investors seem to be skeptical as to the efficacy of these moves. The implications of this crisis include a continued volatility in the markets, along with a weak Euro. Only time will tell whether or not these countries will be able to recover from their current tailspin.

By Indraneal Balasubramanian and Lakshya Sharma