Eurozone faces tough hurdles early in 2012

By David Mchugh

Associated Press

Published: Thursday, Dec. 29 2011 12:00 a.m. MST

Two men check a monitor displaying the stock exchange index in Milan, Italy, Wednesday, Dec. 28, 2011. Italy saw investors more willing to part with their cash Wednesday as it raised euro10.7 billion ($14 billion) in a pair of auctions, a sign that market jitters may be easing as the country presses ahead with its austerity measures.

Luca Bruno, Associated Press

Enlarge photo»

FRANKFURT, Germany — After a hugely-turbulent 2011, the 17 countries that use the euro will be quickly confronted in the new year with major hurdles to solving their government debt crisis, just as the eurozone economy is expected to sink back into recession.

With government finances under pressure as growth wanes, the eurozone will find it even more difficult to shore up its shaky banks and keep a lid on the high borrowing costs that threaten Italy and Spain with financial ruin.

As early as the second full week of January, bond auctions in which Italy and Spain need to borrow big chunks of cash will start showing whether the eurozone is finally getting a grip on the two-year-old crisis that has seen three countries bailed out.

If the auctions go well and borrowing costs ease, then hopes may rise that the strategy of getting governments to embark on often-savage austerity measures to reduce deficits, along with massive support for the banking system from the European Central Bank, may be working.

If rates are still high and show that investors remain nervous about lending to governments, then fears will rise of a government debt default that could cripple banks, sink the economy and, in the extreme case, destroy the 17-member currency union.

Key events early in the New Year:

— Italy and Spain will seek to borrow heavily in the first quarter at affordable interest costs, starting the second week in January.

— The slowing eurozone economy may slip into or already be in recession, lowering tax revenue and increasing government budget deficits.

— Bailed-out Greece must agree with creditors on a debt writedown that will cut the value of their holdings by 50 percent in an effort to start putting the bankrupt country back on its feet.

The major players — eurozone governments, the European Union's executive Commission and the European Central Bank — must work together to convince financial markets that troubled governments can pay their heavy debts and therefore deserve to borrow at affordable interest costs.

Default fears have driven up bond market interest rates and made it more and more expensive for indebted governments to borrow to pay off maturing bonds. That vicious cycle forced Greece, Ireland and Portugal to seek bailout loans from the other eurozone governments and the International Monetary Fund.

A key stress point will be whether Italy can continue to raise money in the markets at affordable rates.

In the first quarter, it has to step up its borrowing to pay off €72 billion ($94 billion) in bond redemptions and interest payments. Spain, which is expected to sell up to €25 billion ($33 billion) in new debt, starts a heavy period of auctions on Jan. 12, and Italy begins on Jan. 13.

Overall, Italy will have to borrow over €300 billion ($392 billion) in 2012.

Italy's auctions are "absolutely pivotal," said Jane Foley, an analyst at Rabobank International.

"If Italy manages to auction this debt successfully, then the debt crisis will take a step back from the cliff edge," Foley said. "If it doesn't, it could go over the cliff edge. At the end of the day, whatever the nuances and hours of discussion that have gone on about the sovereign debt crisis, it boils down to whether a sovereign can sell its debt in the open market."

If Italy fails to borrow at affordable rates, the options are few and unattractive. The eurozone's €500 billion ($653 billion) in bailout funds — already partly committed to earlier bailouts — would struggle to cover Italy's financing needs, even if additional help can be found from the IMF. A bigger solution — commonly guaranteed eurobonds — faces German resistance and would take time to implement.

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