A dark road lies after Greek hurdles

While investors spent the week nervously puzzling whether a possible Greek debt default could trigger a Lehman-type shock to the global economy, economists were pointing to a more insidious risk: the deep recession that now threatens major eurozone economies.

Figures released this week showed that the Spanish economy, the fourth largest in the eurozone, shrank by 0.3 per cent in the final three months of 2011. But the economic downturn is expected to become even more brutal in coming months, with the Bank of Spain predicting the Spanish economy will shrink by 1.5 per cent in 2012.

One reason for the sharp decline is the decision by Spain's recently-elected conservative government to make savage spending cuts. Spain's budget deficit hit 8 per cent of GDP last year, but the Spanish government has set itself the target of reducing the budget deficit to 4.4 per cent of GDP. And this will require massive spending cuts and tax hikes, which will cruel economic activity.

Even then, some economists doubt that the Spanish government led by Mariano Rajoy will be able to meet its new target. They point out the Spanish government will have to make €40 billion ($52.6 billion) in spending cuts this year, well above the total savings of €28 billion that were achieved in 2010 and 2011.

The budget cuts come at a time when Spain is battling the highest level of unemployment in the eurozone. Spain's unemployment rate is now 23 per cent, or more than 5 million people. For young people, the jobs outlook is bleaker, with Spanish youth unemployment now close to 50 per cent.

The trouble is that continuing budget deficits, combined with a bleak outlook for economic growth, means that Spain's debt burden will keep climbing. According to the International Monetary Fund, Spanish government debt is likely to rise from just over 70 per cent of GDP last year to 84 per cent next year.

Meanwhile the Italian economy, which is the third-largest in the eurozone, shrank by 0.7 per cent in the final three months of 2011. This means that the country is now suffering its fourth recession in just over a decade.

Economists warn that the weak performance of the Italian economy means that markets will continue to fret about the high level of Italian government debt – which stands at €1.9 trillion, or around 120 per cent of GDP.

Italy's new technocratic government, led by the economist Mario Monti, has also outlined a savage budget-tightening strategy of around 4 per cent of GDP. The combination of hefty cuts to government spending and widespread tax hikes will deal a heavy blow to the Italian economy.

But despite this massive fiscal belt-tightening, many economists believe that the Italian government's finances could see little improvement. Last year the Italian government managed to achieve a slight 'primary' budget surplus (that is, before interest payments). But economists warn that the deepening Italian recession will hit economic activity which will cause the country's tax take to dwindle, and this will likely offset the Italian government's efforts to boost its tax revenues.

Meanwhile, France, the eurozone's second largest economy, narrowly averted a 'double-dip' recession by recording a growth rate of 0.2 per cent in the final three months of last year. But economists warn that the improved economic performance in the final quarter of last year was largely due to record Airbus exports. They warn that the French economy will probably slip into recession this year.

They point out that France's export performance has been poor, with the country lagging Germany, Italy and Spain in terms of boosting export sales last year. At the same time, the French economy has been hard hit by rising oil prices, which were largely responsible for pushing its trade deficit to balloon to a record €70 billion last year.

Some analysts warn that the grim outlook for growth in Spain, Italy and France means that the eurozone's debt crisis is far from over, even if Greece avoids a "Lehman” moment.