Greek crisis wakeup call as IMF warns of the beginning of a new phase in global financial crisis

This is not the time to hit the snooze button, as International Monetary fund names Greek fiscal crisis a “wake-up call” on sovereign debt risk.

This morning the Euro slipped against the U.S Dollar (on the forex market) as Greek officials prepare to join counterparts from the Euro-Zone, the IMF and the European Central Bank, today, in order begin hammering out the deficit-cutting measures the debt- stricken nation will need to accept in order to tap the EU-IMF joint €45 billion emergency bailout package. According to reports, the Greek government needs to raise about €10 billion by the end of May, as its soaring financing costs are lending urgency to the talks.

Despite earlier claims, the Greek Finance Minister acknowledged yesterday that Athens could be compelled to seek rescue financing from its European Union partners and from the International Monetary Fund. A rise in unemployment along with soaring market interest rates has applied more and more pressure on the already floundering nation. George Papaconstantinou said that the country would not be left “high and dry” next month when it needs to refinance its existing borrowings, as he declared that “Greece will borrow either from the markets or from its partners”.

Greece’s ongoing battle to finance a deficit equivalent to 12.9% of its gross domestic product, and more than four times the European Union allowed limit, has undermined the credibility of Europe’s monetary union and has led to a 6.1% drop in the single currency value this year, as forex investors seek refuge in more risk adverse currencies. Budget deficits across the region have surged as the financial crisis forced government to bail out banks and spend billions on stimulus to ease the effects of the worst recession in since the great depression.

Despite a joint commitment from the EU and IMF to provide a €45 billion financial rescue package, the market has failed to rally behind Greece. The gap between the yield on its ten-year bond and the equivalent German benchmark bond rose to a record 4.91% points, taking the Greek long-term government borrowing rate above 8%. While a default by Greece would be detrimental to the other Euro Zone countries, and several harm the stability of the EU and its single currency, the severity of the Greek crisis has shed light on a new potential threat to the global economy.

According to the IMF, Greece’s upheaval could mark the starting point of a “new phase” in the global financial crisis, one marked by increased concerns over rising sovereign debt. While the IMF slashed its projections for bank losses from the crisis to an amount deemed manageable, the rapid buildup of sovereign debt among advanced countries to levels not seen since the end of World War II has emerged as the biggest threat to global financial stability. “In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured,” said Jose Vinals, director of the IMF’s monetary and capital markets department, as the IMF warned that “Higher debt levels have the potential for spillovers across financial systems, and to impact financial stability”.

Mounting risks of sovereign default can create a reaction that will affect the entire global economy including pushing up interest rates on government debt, which in turn will cause interest rates on commercial debt to increase. A diminished faith in the value of government guarantees can also push up borrowing costs across nations as the market demands higher interest rates for commercial debt. Two former senior IMF economists, Kenneth and Rogoff, have been warning that banking crises frequently lead to sovereign debt crises several years later, in part because governments spend so heavily to restore their banking systems to health – which is exactly what the IMF fears will happen.

Jose Vinals, director of the IMF’s monetary and capital markets department, warned that “Greece is a wake-up call!” In all other countries, which fortunately are in a better situation, what we are saying is do not let the financial situation get out of hand and undertake the necessary measures precisely to remain on the safe side.” According to the IMF, careful management of sovereign risks is essential: governments need to design credible medium-term fiscal consolidation plans in order to curb rising debt burdens and avoid taking the credit crisis into a new phase.

Mr. Vinals went on to say “Now that there is time, it’s very important that these emerging sovereign risk concerns are addressed through appropriate policy action, precisely in order to consolidate financial stability”. However, whether this “Greek siren” was heard in time, and whether the world’s developed countries can act now remains to be seen – it is a very complex and dangerous situation, one that is further complicated by the fact that heightened market concerns about sovereign debt could require some countries to start removing fiscal stimulus sooner than planned – something that many governments might be too fearful of to even contemplate.