THE month of October leading into November was challenging for the global markets as Eurozone concerns led to fluctuations in market dynamics. A recent summit of Eurozone leaders was largely inconclusive; however the outline of a deal was agreed. Eurozone leaders have agreed to impose regulations to force banks to protect themselves against future losses and have agreed to increase the size of the bailout fund from ¤440 billion. On the negative side, lenders to Greece were asked to accept much deeper losses in the range of a 50% haircut via a voluntary debt exchange.

The market breathed a collective sigh of relief as the cut would yield Greece savings of approximately ¤130 billion and the possibility of the crisis coming to an end led to a reduction in Eurozone bond yields. As a result the EUR/USD rallied from 1.35 to 1.42, a gain of 4%, over a four-day period. The turmoil however restarted when the PM Papandreou announced that a referendum would be held to decide whether further austerity measures would be accepted. This would have resulted, based on the behaviour or the Greek public — riots etc, in a clear vote of no jeopardising a ¤8-billion payment due in December from the European Union and the IMF. The non-payment of this money would result in bankruptcy for Greece.

This led to a reversal of Euro currency gains until the PM held a confidence vote which he won by a majority of two. After the confidence vote Papandreou announced that there would be no referendum. Then on Sunday night his nerves along with international and domestic pressure finally led him to announce his retirement.

What Does This Mean?

The resignation of the PM means that the Greek parliament will have to announce a nominee in consultation with the opposition. The nominee will then have to be approved by the president then approved by Papandreou’s old ruling party the PASOK. The interim PM will then have to put together a temporary coalition government to run the country and approve the joint IMF/ECB proposals to avoid bankruptcy until elections are held within the next few months. Based on the above criteria it is clear that political volatility remains and there is still no end in sight to the crisis as the waters remain “murky”. A hitch in any of the mentioned procedures will send markets tumbling in our opinion. As shown below the yield on Greek debt has gone as high as 20% and the sovereign is rated at imminent default by Standard & Poor’s (“CC+”).

Other Signs of Trouble in the Eurozone

Italy also came up for mention with German Chancellor Angela Merkel noting after a meeting with her Italian counterpart that while the Italian economy had great strength, they did have a high debt level that needed to be reduced in a credible way in the years ahead. Italy’s total nominal debt is the highest in the Eurozone at almost ¤2 trillion, their debt to GDP comes in at 120% and they have consistently run a fiscal deficit of approximately 3% over the last 5 fiscal years. While a fiscal deficit of approx 3% may seem prudent, this is not necessarily so given the size of their debt.

Other concerns which weigh heavily on Italian fundamentals include the fact that economic growth has been stagnant or anaemic, averaging less than one per cent (0.6%) over the last ten years. These fundamentals have resulted in a downgrade by all three rating agencies over the last two months. In response, the government attempted to introduce austerity measures including a bill to raise the retirement age by two years to 67. This prompted the suspension of parliament after a brawl broke out between lawmakers.

Currently Italian debt is being severely pressured by investors with the markets demanding 6.4% to invest in 10-year bonds. The markets regard a funding cost of 7% as the benchmark which if breached, makes it difficult to fund deficits in the Eurozone. Further to the aforementioned concerns, Italy is the third largest economy in the Eurozone making up approximately 17% of total Eurozone output. Greece Ireland and Portugal combined account for only 6%. Consequently the challenges facing Italy could represent a much greater crisis than the other economies that have been in trouble.

At the time of writing this report, the Italian Prime Minister Silvio Berlusconi has announced that he will resign after the passing of the country’s budget. The PM apparently has lost the confidence of the Italian parliament and will not have the political capital to push through the tough reforms needed to turn the Italian economy around. Italian bond yields have also come under pressure and face furthers tests in upcoming days.

Implications for Jamaica

It is clear that the data coming out of the Eurozone suggests that the probability of another global recession is rising. This further increases the importance of IMF negotiations. If the worse case should materialise, Jamaica would not want to be caught in a global crisis without an IMF and multilateral support window to access.

If Greece does not address political issues quickly and vote to have further austerity measures put in place then they may not access the Euro 8 billion needed by December. Without this funding an outright default is a possibility; this scenario is worse than the scenario of a voluntary principal haircut because the voluntary move would only affect Eurozone banks. If the default is forced banks in the US could need a further bailout from the Federal Reserve. In this scenario Federal Authorities would further pull down on fiscal resources, increase debt and possibly face another rating downgrade in the medium term.

Jermaine Burrell is the Senior Economist & Sovereign Research Manager at JMMB