Sovereign debt, the euro-zone and the markets: Not reassured

THERE is just no pleasing some people. Politicians pulled out all the stops in their efforts to rescue Ireland. They even agreed that the senior bondholders in the banks would get away without suffering a haircut, even though natural justice might suggest they should. All this was intended to ensure that the rot stopped with Ireland, and that Portugal and Spain would be considered as safe. But the cost of insuring Spanish and Portuguese debt, as measured in the credit default swap market, has risen to a record high today.

Why the negative reaction? The problem with the bailout is that it doesn't really solve much. Perhaps the higher capital ratio being imposed on Irish banks might persuade foreign depositors to keep their money in Irish banks, but as I argue in my latest column, there is no real incentive for nervous depositors to take the risk of hanging on. The bailout package will tide the country over in the short term. But an interest rate of 5.8% is still more than the country can afford. Since the economy is not going to grow at 5.8% a year, the debt/GDP ratio will keep rising. At the end of the bailout term, Ireland will still have very high debts.

The issue is just the same for Greece and Portugal which have both shown, by consistent current account deficits, that they have a competitiveness problem. A temporary loan doesn't solve this problem. That leaves default, or devaluation or both; solutions which naturally make creditors nervous. the yields on peripheral country bonds rise sharply at longer maturities. The CDS market is pricing in a 77% chance of Greek default over the next 10 years.

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