Greece, Spain staring into the abyss

The magnitude of the problems in the weakest countries in the Eurozone continue to hit the headlines.

In Greece, the unemployment data for July reinforce the fact that there is an economic depression, while Spain's credit rating downgrade to just one level above junk status shows how far it is from fixing its problems.

In Greece, the unemployment rate rose for a remarkable 35^th straight month, reaching a depressionary 25.1 per cent. It has risen a quite extraordinary 7 percentage points in the last year and with a range of austerity measures still to kick in and falls in GDP forecast for 2013 and even 2014, the unemployment rate could yet rise further.

A recent Bloomberg survey of market economists saw the consensus forecast for Greek GDP to fall 3.1 per cent in 2013 and a further 0.3 per cent in 2014. A return to positive economic growth is unlikely before 2015. Youth unemployment has risen to 54.2 per cent.

Recent data for Spain showed it too had an unemployment rate of 25.1 per cent.

The arguments over the bail out conditions for Greece from the IMF, the speed at which the Samaras government is implementing its austerity packages, and even the debate about whether Greece should just leave the Eurozone are put into context with these labour market data and what will soon be a seventh straight year where GDP has fallen.

IMF Managing Director, Christine Lagarde, is sympathetic to the plight of the Greek economy acknowledging that Greece could get 2 years to implement its fiscal reforms.

Lagarde is still firmly of the view that the fiscal policy targets should be met as a necessary condition for Greece to qualify for EURO 130 billion of additional bailout funds, but she said that "it's sometimes better to have a bit more time … This is what we advocated for Portugal, this is what we advocated for Spain and this is what we are advocating for Greece”.

Some market watchers are concerned that any potential relaxation of the timetable for fiscal reforms in Greece will make it near impossible for Greece to meet it targets. They note that the current long run target for government debt, of reducing it to 120 per cent of GDP by 2020, will be more difficult, if not impossible to achieve if as now appears likely that the debt will hit 179 per cent of GDP in 2013.

They point out that to get to 120 per cent of GDP by 2020, budget surpluses will need to average around 8 to 9 per cent of GDP for the 7 years from 2014.

Given that Greece has never run a budget surplus, these concerns appear well founded.

Despite this, Lagarde tried to act as a fair broker, saying that, "we will spare no time, no effort to actually do as much as we can in order to help Greece”. The IMF's purpose is "to make sure that Greece is back on its feet, that it can one day return to markets, that it doesn't have the need for constant support.”

In Spain, the credit rating downgrade from Standard & Poors (S&P) to BBB-, was no real surprise. The tardiness of the Government's implementation of fiscal reform and its reluctance to embrace the conditions so that it can participate in the ECB's bond buying program is unhelpful for the ratings outlook.

Despite the promise of bailout funds, the rating downgrade has seen the yield on Spanish 10 year government bonds remain around 425 basis points above those of AAA rated Germany. While this is narrower than the peak of around 600 basis points reached just before Mario Draghi said in June that the ECB would do "whatever it takes” to hold the Eurozone together, it is a significant problem for the government that is still managing to control its debt levels which are around 90 per cent of GDP.

The wide differential between Spanish and German bonds reflects investor concerns about the credit worthiness of the Spanish government. That concern is fully justified, it seems, with S&P commenting that a "deepening economic recession that could lead to increasing social discontent and rising tensions between Spain's central and regional governments”.

S&P added, "The negative outlook on the long-term rating reflects our view of the significant risks to Spain's economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy.”

While there are some grounds for hope that the eurozone is taking steps to fix its problems, the path to full reform is very long and is littered with many steep hurdles that threaten to trip up the markets from time to time.