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Liliana Rojas-Suarez on the European Crisis (CNN en Espanol)

1/20/11

Senior Fellow Liliana Rojas-Suarez made comments on the sovereign debt auctions held recently by several European governments. She thinks the so-called success of these auctions is relative for two reasons. First, it is important to remember that before this auction took place, the European Central Bank intervened to buy sovereign bonds in order to lower spreads in the market, which at the time were sky-high. Second, an important proportion of these bonds have been bought by local investors. It is, therefore, worrisome that the liquidity that the European Central Bank has injected into a number of European banks might be channeled (at least partly) to the purchase of sovereign bonds. The concern is that in the event of sovereign debt defaults, banking crises would also ensue.

Rojas-Suarez also noted that the cost of financing for the peripheral Euro-zone countries (Ireland, Greece, Spain, Portugal, and Italy) is not low. Interest rates in Europe, which are around 4 to 7 percent, are relatively high compared to rates in the rest of the developed world, which are close to zero. Furthermore, the yields on the sovereign bonds of these countries have risen at each and every recent bond sale. Rojas-Suarez highlighted that a key fact now is that every single month of 2011 will see bond auctions from two or more of these countries. Given the extremely high debt ratios of these countries, Rojas-Suarez believes a major concern is the formation of a vicious circle: yields will continue to rise, which implies that these countries will have to implement further adjustments to their economies that will be even less acceptable to the majority of citizens. This in turn will increase the probability of default, raising yields even further.

Rojas-Suarez added that the low level of competitiveness in these countries significantly exacerbates the difficulties of resolving their debt problems. To improve competitiveness, European countries will need to implement reforms to their retirement systems and social welfare programs, as well as carry out reforms to increase the flexibility of their labor markets. Given current political pressures and the electoral calendar (Portugal’s elections will take place at the end of the month), it is unlikely that most of the reforms needed to prevent a deepening of the crisis will be implemented. In Rojas-Suarez’s view, it is just a matter of time before we observe further rescue packages from the European Union (EU). In her view, however, in the current volatile international environment, the likelihood that EU rescue missions will be successful is not very high.

Finally, she concluded the interview by warning that if at least two countries in the region default on their sovereign debt, then the Eurozone itself will be in danger.

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