The Greek tragedy: how will it affect you?

29 April 2010

Europe’s financial crisis intensified at the end of April with Greece, Spain and Portugal having their credit ratings downgraded. Meanwhile, Germany questioned whether Greece should have been allowed to join the monetary union and the euro hit a new low against the dollar.

But what’s the Greek financial crisis all about and how will it affect us? We answer your questions about the Greek tragedy:

Q: What went wrong?

A: Basically the Greek government failed to reform the economy and reduce public spending, including the huge military budget, when it joined the eurozone. When the recession came along, Greece was ill equipped to cope. Government debt was bigger than the economy last year and is forecast to exceed 120% of GDP this year.

Q: How does this affect the financial markets?

A: Greece needs to borrow €50 billion this year to pay its bills, but its bad credit rating means it must pay much higher interest on its borrowings than other eurozone countries. In principle it’s been offered a €45 billion rescue package from Europe and the International Monetary Fund, but increased borrowing costs, and political opposition in Germany, means a bigger rescue package might now be necessary.

If the bailout package isn’t agreed at a eurozone leaders emergency meeting on 10 May, Greece will default on its existing debt on 19 May.

Q: What happened this week?

A: Short-term borrowing rates hit 38% on Wednesday 28 April after credit rating agency Standard & Poor's downgraded Greek sovereign bonds to junk status. Now investors are worried that Greece won’t be able to pay its debts. Meanwhile, Portugal's rating was lowered to A- and Spain’s from AA+ to AA.

Q: Why is this so bad?

A: All this is bad news for Greece because it will find it very difficult to borrow money in the future. In turn, it will struggle to pay all its public sector employees and the recession will get worse.

Q: Will the problems spread?

A: Standard and Poor’s has already downgraded government debt issued by Spain and Portugal and investors are fearful the problems in Greece are spreading to other peripheral nations. Duncan Higgins, senior analyst at Caxton FX, says: "Clearly the danger for European officials is that the fiscal turmoil in the eurozone will spin out of their control. It now appears that Portugal is treading a precariously similar line to Greece."

Q: What about the UK?

A: UK banks have around £100 billion exposure to Spain, Greece and Portugal. Research from Credit Suisse says that Barclays Capital and Royal Bank of Scotland have the largest holdings in the three countries among UK lenders.

A lack of investor confidence could make it more expensive for the UK to borrow money.

Because we’re not in the euro, we’re likely to see a fall in sterling first rather than investors refusing to buy government bonds. Interest rates could rise too – and push the country back into recession.

Q: Will the UK’s credit rating be downgraded?

A: It’s possible. A lot depends on the result of the election and what action the new government takes. Last month, Standard and Poor’s said the UK’s AAA rating could be under threat if the next government failed to take action to slash public borrowing.

Credit ratings agencies such as Standard and Poor’s (also Moody’s and Fitch) provide investment and credit opinions on the ability of companies and countries to meet their debt obligations. The agencies’ views are critical to investment decisions made by banks, pension funds and other financial institutions.

A downgraded credit rating could wipe millions of pounds off bond and share prices as well as making credit more expensive, both for the country and consumers. If the UK credit rating is downgraded there’s a risk that the country could see another credit crunch or the return of the recession.

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