New Worries Darken Greece's Prospects

The crisis of confidence in Greece's ability to tame its budget deficit deepened yesterday as Greek government sources confirmed that European Union inspectors now in Athens expect the country to miss its targets for deficit reduction.

Surrounded by more mass protests against the Papandreou government's austerity programme, EU officials believe that Greece's contracting economy and rising debt costs will make it difficult for Greece to meet its obligations, according to Greek sources. It must roll over €25bn (£22bn) of debt in April and May.

George Papandreou was, in effect, placed out "on report" by fellow EU leaders at their last summit in Brussels, and he will be required to report monthly on his country's progress. Such tight supervision is being demanded as the price for maintaining Greek membership of the euro and averting a potentially fatal crisis in the eurozone.

"Negotiations are continuing because they see a big slippage in targets," commented the Greek official.

Greece has committed to chop its deficit from almost 13 per cent of GDP to 9 per cent next year, but EU officials seem privately sceptical that the improvement will exceed 1.5 to 2 percentage points, leaving the ambition of undercutting the Stability and Growth Pact's 3 per cent limit by 2012 doubtful. The Greek government has announced a freeze on civil servant wages and a 10 per cent cut in salaries, though EU finance ministers are said to be pressing for a rise in VAT on luxury goods and still more cuts. Inevitably, though, these will have a depressing effect on the Greek economy and make its adjustment even more painful.

A more immediate problem is the warnings from credit agencies that Greece's sovereign debt faces further downgrades. Yesterday Pierre Cailleteau, the head of Moody's (MCO) global sovereign ratings, told Reuters in an interview that Moody's would follow the situation in Greece and see what was happening on the ground.

"We have to look at the facts and whether the government of Greece is going to do what it has promised to do," he said.

Standard & Poor's (MHP) has already publicly contemplated a reduction to BBB, which would leave Greece level with Hungary, which was rescued by the IMF.

The US Federal Reserve has weighed into the row over whether Greece used unusual derivatives to mask breaches of euro membership rules. Ben Bernanke, the Fed chairman, said in testimony before Congress: "We are looking into a number of questions relating to Goldman Sachs (GS) and other companies and their arrangements with Greece."

Goldman has come under fire for currency swap deals in which the Greek government engaged in December 2000 and July 2001. They cut the country's debt – as measured by official statistics – by €2.4bn, which Goldman will recoup over time. The bank has said it regrets that the swaps were not more transparent, but insists they made little difference to the scale of Greece's problems.

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