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ECB’s Game of Chicken on Crisis Has Risks, Fitch’s Riley Says

Policy makers’ efforts to end Europe’s debt crisis face government backsliding and stretched budgets, said David Riley, head of European sovereign debt at Fitch Ratings. The region’s fiscal turmoil will last at least another year, he predicted.

Riley, who’s based in London, commented on the crisis at a presentation in Toronto.

On the euro and crisis measures:

“We don’t believe the break-up of the euro is nigh, but we do believe European economic and monetary union as currently constructed needs reform.”

“It will be at least 12 to 18 months before we have stabilization for the euro zone. This is going to be a long, hard slog punctuated by extreme market volatility. The European Central Bank’s reluctance to be more interventionist in sovereign bond markets is in part to keep pressure on governments not to backslide on their fiscal austerity and reform programs.”

“There are, though, risks with this sort of game of chicken being played with the market and governments. But the ECB bank-refinancing operations have been aggressive and clearly positive in easing sovereign as well as bank funding pressures.”

“A potential expansion of the so-called firewall by bringing forward the European Stability Mechanism and possibly adding to the remaining uncommitted guarantee commitments of the European Financial Stability Facility would be positive. But there are constraints on how far the balance sheets of AAA sovereigns can be stretched.”

On Portugal:

“‘Risks haven’t risen dramatically in the near term in the way suggested by the way bond yields have. They have an International Monetary Fund program in place, and they are meeting its conditions. But medium-term risks are significant, which is why we downgraded Portugal to sub-investment grade last November and it remains on negative outlook.”

“They are opening up the economy to privatization and trying to make it easier for foreign capital to enter the country. One way to characterize that strategy is to think of it as a debt-for-equity for the economy to reduce private-sector and foreign indebtedness. It’s one way of thinking about how the government is trying to reform the economy.”

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