Greece is facing a very difficult situation with it’s bond market reduced to ‘junk bond status’ Interest rate on two year Greek bonds have an interest rate of 18%. See: European Fiscal Crisis
Countries have experienced higher levels of government debt as a % of GDP. However, in the case of Greece, there appears a lack of political will to – make cuts within Greece itself (power of trades unions for example) or for other EU countries to offer satisfactory bailout.
Therefore, there is a strong chance of a Greek default or at least partial default. What would happen if that happened?
Markets will be Nervous over other Countries.
- If one EU member defaults, markets will be increasingly suspicious of all countries in a similar position. Interest rates throughout Europe will tend to rise, increasing the cost of repayment and slowing down economic recovery.
- Because of market fears, countries with large debts will be under increased pressure to implement austerity packages (tax increases, spending cuts). However, this fiscal retrenchment will slow down growth and economic recovery. Combined with the deflationary pressure in the Eurozone, growth could be weak for a considerable time – increasing the already high rates of unemployment.
- Pressure on Euro. For many reasons, it is very difficult for Greece to leave the Euro. A debt default would lead to a sell off of Euros pushing it even lower against the dollar and other major currencies. (It is uncertain whether the Pound would actually be preferred to the Euro, given our own debt problems)
How Will it Affect the UK?
- Harder to Borrow. More pressure to cut UK debt. We may have pressure to cut spending at a time which will dampen a fragile economic recovery.
- Higher Borrowing Costs. Markets will tend to put upward pressure on bond yields, making it more expensive for the government to borrow.
- Slower growth in Europe our main trading partner will damage our export sector.
The UK has differences to the Greek situation
- We have longer debt maturity rate. (We need to refinance debt less frequently)
- We have independent monetary policy and have more flexibility to avoid potential of deflation.
- However, the OECD still forecasts the UK to have one of the highest annual deficits at over 13% of GDP in the coming year.
What the recent credit crisis shows is that if markets start to seize up, countries (firms) in reasonably good situations, suddenly start to look much more fragile.