Are global markets set to catch the Spanish flu? Maley

Global financial markets will likely remain agitated this week, with signs that speculators are preparing to launch an attack on Spain, at the same time that the European Union inches closer to a bailout plan for Greece.

Friday’s meeting between Greek prime minister, George Papandreou, and the head of Deutsche Bank, Josef Ackermann, has bolstered hopes that Germany may be softening its tough stance towards Greece. On Friday, the Greek prime minister will fly to Berlin to meet German chancellor, Angela Merkel.

But signs that Germany and France are working on ways to help Greece are likely to roil financial markets. Hedge funds and investment banks have built huge short positions in the euro, and may be forced to scramble to cover these positions.

At the same time, however, financial markets are already turning their attention to Spain’s budgetary woes. Spain, which is four times larger than Greece, has announced its own “stability plan” to slash the budget deficit from 11.4% of GDP in 2009 to 3% by 2013, but the credibility of this plan is already under fire.

Hopes for a bailout of Greece rose further after French finance minister Christine Lagarde told French radio that it was “out of the question that Greece would leave the eurozone”.

“I have no doubt that Greece will succeed in refinancing itself by methods which we’re currently exploring”, Lagarde said on Sunday. These solutions, she said, could involve “either private parties, or public parties, or both”.

She also said she believed that credit default swaps – which provide insurance in the case of a country defaulting, but which can also be used to speculate on a country’s credit worthiness – should either be very tightly regulated or even banned.

Her comments follow media reports on the weekend that German and French officials are considering a bailout plan for Greece of up to $US41 billion ($A45.6 billion). Greece needs to refinance $30 billion of debt that matures in March and April.

One plan reportedly involves Greek debt being sold to state-owned banks – Germany’s state-owned development bank, KfW, and France’s Caisse des Depots, in addition to a bond issue in public markets.

Alternatively, Berlin and Paris may issue government guarantees to German and French banks that buy Greek debt. Three German banks, including Hypo Real Estate, Eurohypo and Deutsche Postbank, which together hold $20 billion of Greek debt, said last week they did not intend to increase their exposures. This situation might change if the debt was guaranteed by the German government.

In return for the aid, the Greek government will have to agree to further austerity measures to reach its target of cutting the budget deficit by 4 percentage points this year.

Greece has already announced spending cuts and tax increases it believes will cut up to $13.7 billion from its budget deficit, pushing the deficit to below 9% this year from close to 13% in 2009. Since then, the country has come up with an extra package of spending cuts and tax rises that it believes will save an extra $3.4 billion.

However, EU officials have declared this is not sufficient to reduce Greece’s budget deficit by 4 percentage points. Instead, they are pushing Greece to agree to introduce policies that will cut $5.5 billion from the deficit.

Last week, Greece came close to total paralysis as major unions launched a 24 hour general strike to protest against the government’s austerity measures. On Friday, Papandreou prepared the country for worse, warning the Greek parliament that “brutal steps” were needed to restore Greece’s finances.

This article first appeared on Business Spectator.