Descent from Greek euphoria

A warning from Citigroup’s chief economist that Spain may be forced into a debt restructure has reignited concerns over Europe's economic crisis.

European debt fears again flared overnight after Citigroup’s highly regarded chief economist, Willem Buiter, warned that Spain may be forced to go down the Greek route and restructure its crippling debt burden.

"Spain is the key country about which I’m most worried,” Buiter said in a radio interview with Bloomberg. "It’s really moved to the wrong side of the spectrum and is now at greater risk of sovereign restructuring than ever before.”

As part of Greece’s second bailout, the country’s private sector lenders – such as banks, insurance companies and pension funds – have agreed to write off more than €100 billion ($US132 billion) of debt, and to accept new bonds worth less than 70 per cent of their original investment. But Buiter warned that this debt deal is not enough. "The Greek sovereign is by no means on a sustainable path so they will have to restructure again.”

At the same time, he warned that Portugal was also at a "very high” risk of a debt restructuring, while Ireland needed "additional official sector support".

Economists are concerned that countries such as Spain and Portugal will face intolerable pressures as their economies slump into deep recessions, pushing their budget deficits higher and making their heavy debt burdens even more punishing. Earlier this month, eurozone finance ministers agreed to ease Madrid’s budget deficit target to 5.3 per cent of GDP this year, compared to the previous target of 4.4 per cent.

Global markets have rallied strongly in recent months, after the European Central Bank moved to ease financial tensions in the region by pumping more than more than €1 trillion into the region’s banking system. This, Buiter noted, had led to "a general feeling of near euphoria at the moment which leads those drowning in liquidity to believe that all troubles are over.” He also warned there was a downside to the ECB’s actions, pointing out that "efforts for recapitalisation, in the case of banks, and deleveraging for governments tend to slacken off" when they no longer face extreme difficulties in funding themselves.

Meanwhile, concerns over the latest Greek bailout have been reinforced by a leaked official memo that points out that Athens will have to push through tough labour market and structural reforms for its latest program to succeed.

According to a report in the French daily Les Echos, the note from the 'troika' – representatives from the ECB, the European Union and the International Monetary Fund who are overseeing the latest Greek bailout – warned that attempts to reduce Greece’s debts to sustainable levels were extremely sensitive to delays in implementing structural reforms. According to the memo, delays would threaten the country’s economic recovery, resulting in higher unemployment levels and a deeper recession.

It was only two months ago that Greece received a payment of €7.5 billion under its second bailout package, which allowed the country to avoid bankruptcy.