Citigroup economists have brought into question what is assumed to be the world’s risk free asset, sovereign debt.And while the world was already worried about the stability of the eurozone’s fringe, Citi also rings the alarm bells over what are supposed to be safe sovereigns: the U.S., Japan, and UK.
While many investors and market commentators have seen this coming, for a major investment bank to tackle the issue and in harsh terms break down the difficulties facing several states, is a sign the situation may be deteriorating further.
Outlook: Weakest in the eurozone, Greece is the eurozone country most likely to need to restructure its debt in 'the next few years.'
Details: Greece may appear to be making short term progress, but the costs of servicing its debt will continue to rise, all the way to 8% of GDP by 2013. The country is already politically unstable, and further austerity measures will be met with further protest.
It has, an continues to look unlikely that Greece will be able to access private markets after May 2013, without a restructuring of its debt.
Outlook: Ireland's sovereign created its own problems by bailing out its banks. The question is whether the banks or the sovereign default (or both).
Details: Ireland is in its weak sovereign debt position because it bailed out its banking sector. The funding package set up by the European Union and IMF doesn't fix this problem, because it does not restructure the country's banking system. The threat is that Ireland's new government (or more nationalist government after) does restructure, and banking sector contagion impacts the rest of the eurozone.
Outlook: Portugal is likely to tap the European bailout fund soon, because the yields on its government debt have surged.
Details: Portugal's sovereign debt problem looks more like Greece's than Ireland's: low growth, high debt. It has a large private sector debt problem as well, which means the deleveraging process may not have even started yet. The country will most likely face recession again in 2011.
Outlook: Spain's real estate crisis, troubled banking sector, and massive unemployment problem could push the country to tap EU-IMF support, which would not be big enough to support the country.
Details: For Spain, the immediate concern is that the banking sector could have problems and drive up costs for the government. Austerity measures could hit tax receipts, and growth, causing the country to seek help from the EFSF.
The current fund does not have enough money to bailout Spain, so the impact would be an increase in the size of the fund and costs for each state.
There remains the possibility that Spain muddles through this crisis, however.
Outlook: Italy's decision not to engage in high levels of fiscal stimulus have limited the its rise in debt, and the government's continued conservatism is keeping debt markets calm. This could change if a political crisis erupts, or through an event triggered by a high rollover of debt.
Details: Italy has some of the same problems troubling other weak eurozone members, like low growth and high debt. But it's not as bad as its PIIGS colleagues. Like Spain, if things were to take a sudden turn for the worse, Italy's problem would be too big for the current EU-IMF bailout fund.
Outlook: Belgium's debt risk is mostly associated with its weak political situation. There hasn't been a government since the country's election in June and nationalist parties are gaining power, pushing for a breakup of the state.
Details: The debt problem isn't so bad in Belgium, even though it was 96.2% of GDP in 2009, because the country has shown its ability to cut the deficit during growth periods. The political risk remains, however, that the government will slice up its debt between Flanders, Wallonia, and Brussels.
Outlook: France could lose its AAA rating if it doesn't cut its spending through strong fiscal reforms.
Details: Markets are starting to look at France differently than the other big AAA sovereigns Germany and the UK. Its yields are rising, as the government's deficit outlook looks too rosy.
Outlook: Aggressive fiscal cuts have calmed markets, and the UK looks to be on the right track.
Details: The coalition government's aggressive cuts have put the country on a path toward a deficit of 1% of GDP in 2014/1015. Problems in the eurozone could pose contagion risk for the UK's export sector, but it becomes more appealing for investors seeking safe haven at the same time.
Outlook: Japan needs the largest restructuring of its public debt to get to a stable fiscal path, according to the IMF. It continues to borrow at very low rates, nevertheless. There is the threat of a yield spike looming.
Details: Japan's low growth outlook and ove-reliance on its domestic market for debt purchases threatens its debt situation. Without a serious move to handle its fiscal balance, Japan could be hit with what Citi call a 'fear equilibrium,' in which investors begin to believe the possibility of default exists, yields spike, and so default becomes more likely.
Outlook: The U.S. may have the biggest debt problem overall, but it is supported by better growth potential than most of the eurozone or Japan. Markets continued to view the U.S. as risk-free in terms of both inflation and default, however, and that's keeping yields low.
Details: The U.S. situation looks even worse when including Fannie, Freddie, or unfunded liabilities. But markets risk free view of the U.S. is allowing continued use of fiscal stimulus (tax cuts) to drive growth.
It may take a major fiscal crisis for Democrats (no cuts to entitlement programs) and Republicans (no tax increases) to come to the table and sort out a fiscal package.
Outlook: The government has lost support from the IMF; The EU may back out of providing liquidity support; serious risk of a crisis.
Details: Hungary needs to get back on the good side of the IMF and EU, by leaving its Central Bank alone and pushing for serious cuts to its spending.
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