Three aspects of the escalating euro area crisis get examined in this month's EFIC newsletter, World Risk Developments – the Greek election, the Spanish bank bailout, and Cyprus’s banking difficulties.

According to EFIC chief economist Roger Donnelly, ‘The victory of the centre-right New Democracy party in Sunday's Greek general election has damped fears of an imminent euro area exit, but kept alive doubts about Greece's continuing adoption of the euro – and indeed the euro area’s longer run survival.’

‘The market's worst fear was a victory by the far-left Syriza coalition, because Syriza had threatened to tear up the country's bailout agreement', says Donnelly. ‘In such a confrontation between Greece and its official rescuers, the consequences could have been severe, including: debt repudiation, a banking collapse, Greece's exit from the euro area, and spillovers to other vulnerable countries on the periphery of Europe.’

He believes the New Democrats’ victory should head off such a meltdown. But he doesn't think that Greece’s existing bailout program is a workable one. ‘As we have argued previously, the austerity isn't working. This means that the risk of an eventual Greek debt repudiation and exit from the euro area plus attendant ‘contagion’ remains considerable.’

Turning to Spain, EU leaders announced on 9 June that they will lend the Spanish government up to €100 billion to recapitalise the country’s failing banks. This makes Spain the fourth and largest euro area economy to get EU help – behind Greece, Ireland and Portugal.

Will the support solve Spain's crisis? And put an end to the cross-border contagion? ‘Neither is assured', Donnelly believes. ‘Disappointingly, the support won't go directly to the banks: the EU bailout rules forbid this. The funds will instead be channelled through the government’s books, potentially adding as much as 20% to public debt, which is unsettling financial markets.’

‘Therefore it is impossible to rule out the government seeking a full bailout.’

‘All eyes will now be on the EU summit scheduled for 28 June’, says Donnelly. ‘This meeting will reportedly discuss options to reflate the wider euro area economy and achieve tighter economic integration. This offers the promise of calmer markets and some ‘growth-oriented adjustment’. The trouble is, the measures are controversial, and could be rejected.’

Finally, Cyprus: Nicosia is widely expected to be the next government to apply to the EU for a bank bailout.

Donnelly notes that ‘As well as suffering from a property bust like their Spanish counterparts, Cypriot banks suffer from large exposure to Greece, the write-down of which has decapitalised them. Already the government has gone to Russia for a €2.5 billion rescue loan to cover its maturing debt. And now it is considering approaching Brussels for a bank bailout.’

In other stories, the newsletter looks at the Chinese and Indian slowdown, the commodity price correction, political instability in Thailand, and easing sanctions on Burma.

21 June 2012