New Urgency to Prevent Greek Default

The decision by rating agency Standard & Poor’s (AP) to downgrade Greece’s sovereign debt to junk status rattled global markets after weeks of uncertainty about the country’s economic status. CFR Senior Fellow Marc Levinson says the downgrade may compel German Chancellor Angela Merkel--who has pressed Greece for more budget cutbacks in advance of a bailout--to moderate her position to prevent a Greek default. Investor fears are rising that other eurozone countries like Portugal and Spain may also default on their debts, says Levinson, but an improving global economy that boosts trade and tourism in European countries could make fiscal adjustments "a bit less painful." Other European countries also want to sustain the value of the euro, which will buoy their "interest in keeping Greece, Portugal, Ireland, and Spain within the eurozone" and helping Greece avoid default, he says.

How does S&P’s downgrading of Greek debt change the prospects of avoiding default and reviving its economy through an IMF-EU bailout package?

The Greek government’s borrowing costs have already risen sharply. At the start of the year, ten-year Greek government bonds were yielding 5.8 percent. They’re now yielding close to 10 percent, so refinancing has become far more costly. The downgrade by itself doesn’t much change that situation.

Will this alter the willingness of private investors to refinance Greece’s existing debts? If so, what implications does that have for Greece’s rescuers?

Private investors have long since come to the conclusion that Greece is a riskier credit than other countries in the eurozone. To a certain extent, investing in Greek debt is a bet that the other countries in the European Union have an interest in avoiding a Greek default to maintain the position of the euro. The S&P downgrade could force banks with outstanding Greek loans to write down the value of those loans, a step they might have been able to put off in the absence of a downgrade. This could give European governments a greater sense of urgency in dealing with the situation.

German Chancellor Angela Merkel issued an emergency statement promising to support Greece. Is the downgrade likely to change Germany’s pre-conditions for support?

Chancellor Merkel’s position accurately reflects German public opinion. Germans do not see why they should sacrifice for the sake of a country where people work less and retire earlier than in Germany. To the extent the downgrade makes Germans more concerned that a Greek default could have undesirable consequences for Germany and the euro, the chancellor may cautiously moderate her position.

Portugal’s debt was also downgraded. How likely is Portugal to find itself in a similar situation to Greece in months to come?

Portugal’s debt problems are much less severe than Greece’s, relative to the size of the economy. Nonetheless, the markets are starting to believe it has a high probability of default. The government and the main opposition party have supposedly agreed on austerity measures, but, as in Greece, there are serious doubts about the government’s ability to actually make large cuts in public spending. There is a credibility issue here, and Portugal’s downgrade may help concentrate minds.

What would prevent this crisis from spreading to other eurozone countries with high debt levels?

There are a couple of things worth keeping in mind. First, the world economy is now in an upswing. If the heavily indebted European countries can get an economic lift from increased exports or tourism revenues over the next year, their fiscal adjustments could be a bit less painful. Second, other European countries have a huge political investment in the success of the euro. No matter what they say about Greece, and they say lots of unpleasant things, they have a great interest in keeping Greece, Portugal, Ireland, and Spain within the eurozone. The process will be messy, but at the end of the day, I expect the EU countries will help Greece restructure its debts and avoid an outright default.