Debt Fears Rattle Europe

By MARCUS WALKER The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent's economic recovery could be derailed. The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday's surprise nationalization of another Austrian bank at the behest of the European Central Bank. Greece is just "the tip of the iceberg," said Norbert Barthle, budget spokesman for the ruling Christian Democratic Union of German chancellor Angela Merkel. The exploding budget deficits of weaker economies have forced Germany and other financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout. Portugal, Ireland, Italy, Greece and Spain, a group traders have disparagingly dubbed "PIIGS," all have huge budget deficits and very low growth prospects, which means their debt is on course to rise further, fast. The countries' wages and costs have steadily risen, but as euro-zone members they can't respond by devaluing their currency, a problem that strains the bonds tying together the currency bloc. Their soaring deficits are testing the credibility of the euro zone's so-called stability pact, in which governments promise not to spend wildly. "Greece is seen in the market as an example of what may happen to other countries in the euro zone," says Diego Iscaro, economist at IHS Global Insight in London. "Europe has a lot of treaties but no clear mechanism for how to deal with such cases." So far, attempts by Athens to assuage the market's concerns have fallen short. Late Monday, Greek Prime Minister George Papandreou promised to cut his country's budget deficit from nearly 13% of gross domestic product this year to under 3% -- the euro zone's cap -- in four years. "We must change or sink," Mr. Papandreou said. Greek bond prices did sink Tuesday, as investors reacted with disappointment to the absence of austerity measures in the speech. The interest yield on Greek 10-year bonds reached more than 2.5 percentage points higher than ultrasafe German bond yields in Tuesday's trading, up from around two percentage points the day before. Other euro-zone government bonds reacted less sharply, but risk premiums for most weaker euro-zone members have risen in the past month. [GREECE_front] Greek Finance Minister George Papaconstantinou visited Berlin and Paris Tuesday to try to reassure governments and markets; he next visits London and Frankfurt. Mr. Papaconstantinou told reporters in Paris he wasn't discussing a bailout. In an earlier interview, the finance minister said he understands the risk if the newly elected Socialist government can't show by early 2010 that a decisive overhaul of public finances is under way. He expects to have to borrow just over €50 billion ($73.22 billion) from bond markets next year. "There is a scenario in which the market dries up" for Greek bonds, he said. "I wouldn't say it's completely out of the question, but it's not likely by any stretch of the imagination." If it happens, Greece would have to go to fellow European Union member countries or the International Monetary Fund for loans, which would come with stringent conditions. "I don't want to be the finance minister who took Greece to the IMF," Mr. Papaconstantinou said. EU officials, publicly and privately, stress that Greece is unlikely to need a bailout provided it follows its words with actions. The treaty on monetary union banned bailouts of euro members, but senior European officials say there are ways around it. One option would be a loan from a financially strong country such as Germany. EU authorities including the ECB would prefer the euro zone handle any assistance internally. But German Chancellor Angela Merkel would favor the IMF as the source of funds, says a senior aide. (Similar divisions were evident when the EU and IMF bailed out Hungary last year.) An IMF-led package might be politically more humiliating for Greece, but better for the credibility of the euro-zone's no-bailout clause, and thus for fiscal discipline in the zone over time, analysts say. Mr. Papandreou called IMF Managing Director Dominique Strauss-Kahn last week, Greek officials say -- but only to discuss the overall situation, not to ask for aid. The two men know each other well, these officials said. In much of southern Europe, declining competitiveness is linked to structural flaws including heavy and inefficient bureaucracy. Recent growth in Spain and Greece depended heavily on construction and consumer bubbles. Italy and Greece have particularly dysfunctional public administrations and chronic tax evasion. "It's hard to see how Italy, Spain and Portugal are going to generate enough growth" to rein in their debts, says Simon Tilford, chief economist at the Center for European Reform, a London think tank. Ireland's economy is more flexible, and Ireland's younger population makes growth easier to achieve, but Ireland is suffering from the weakness of the British pound and U.K. economy, a major Irish market. So far the Greek government has shied away from deep cuts in state spending and wages that Ireland announced to tame its deficit. EU governments, financial markets and credit-rating agencies are piling pressure on Greece to flesh out its promises with a concrete plan by January. But the prospect of Greek austerity has already sparked protests by pensioners, students and public-sector unions in the past two weeks, and officials fear a wave of social unrest. More Politicians and financial markets "want to make us wear an Irish costume," says shipyard worker and labor leader Theodoros Koutras. Mr. Koutras's Communist-backed union confederation, the All Workers' Militant Front, aims to mobilize hundreds of thousands of workers in a nationwide strike on Dec. 17 Thursday. Greece had no problem selling bonds in November, despite riling markets by stating that this year's budget deficit would be nearly 13% of GDP -- twice the previous government's estimate only weeks earlier. Prime Minister Papandreou, attending an EU summit in Brussels on Friday, said massive inefficiency and "widespread corruption" are keeping investment away and hobbling the economy. Athenian cafe owner Costas, who gave only his first name, testifies to that. He says he's had to budget about €10,000 in bribes to various public agencies that he says wouldn't give him various permits he needs until after his new cafe opened for business last month. He is still waiting for a permit to put out chairs and tables. The government admits it doesn't know exactly how many people work for it. That's partly due to a history of haphazard hiring by politicians who have traditionally rewarded supporters with public-service jobs. A hiring spree in the month before the election brought in thousands of salaried "trainees" who have no posts and in many cases no office to go to, according to the finance ministry. Public servants often leave work at 2 p.m., and "many are doing a second job in the afternoon, very often without declaring their second income for tax," says Evangelos Antonaros, a conservative legislator who was the previous government's spokesman. The gray economy extends to the education system, where many Greek students pay on the side to fill in holes left by lackluster teaching. Katerina Karamatsiou, a young Athenian, recalls her high-school physics teacher telling the class: "What's the point in teaching you? You all go for private tuition after school anyway." He offered such after-hours, tax-free tuition himself, she says. Mr. Papaconstantinou says such experiences are common in public services. "When you have to pay doctors in public hospitals with an envelope of money, then there is no public system," he says. As a result, he says, many Greeks ask themselves: "So why pay taxes?" Despite the government's campaign to persuade Greeks that the old ways can't go on, many believe the media and financial speculators are exaggerating the country's problems. Greece, says shopkeeper Athanasia Katsigianni, "is like a creme caramel: Always trembling, but it stays standing." —Brian Blackstone in Frankfurt, Alkman Granitsas in Athens and Andrea Thomas in Berlin contributed to this article. Write to Marcus Walker at marcus.walker@wsj.com