Until recently, much of the world’s attention has been on the US economy’s battle to recover from the financial meltdown. But now, the spotlight is on Europe, more specifically Portugal, Italy, Ireland, Greece and Spain, commonly known as the “PIIGS.” With Greek, Portuguese and Spanish bonds being downgraded in the past week, attention has been sharply focused on what has become a European sovereign debt crisis.

Greece has been the main culprit in this debacle. Despite achieving annual economic growth of four per cent for much of the decade, Greece has consistently run large budget deficits, which the European Union (EU) calculates as 13.6 per cent of Gross Domestic Product (GDP). It is also crumbling under a mountain of debt that has reached EUR 300 billion or about 125 per cent of GDP. This vulnerable economic condition coupled with declining revenues and a weak outlook for economic growth has hurled Greece towards the possibility of bond default. It was therefore no surprise when, last week Tuesday, Standard & Poor’s (S&P) downgraded Greece’s sovereign debt rating to junk grade status. Following the announcement, the Dow Jones Industrial Average (DJIA) fell 213 points or 1.9 per cent, the London FTSE 100 Index fell 2.6 per cent, and the Euro plunged to $1.3145 per US dollar. Conversely, the US dollar index rose 1 point to 82.32 and gold rallied US$15.40 to US$1158.40 per Troy Ounce, representing investor flight to traditionally safe assets and assets that technically rally in a crisis.

It should be noted that the PIIGS haven’t been grouped together for the purpose of creating a catchy acronym, something that the financial world seems prone to doing. High debt/GDP ratios, sustained fiscal deficits, and high unemployment make these economies stand out amongst their European Union (EU) counterparts. As a result, it is expected that if the Greek debt crisis were to spread, it would be reflected in these nations first. When S&P downgraded Portugal from A+ to A- on the same day they downgraded Greece, and then downgraded Spain, a day later from AA+ to AA, it sent a clear signal to the market that the debt crisis was, in fact, spreading in Europe among the PIIGS.

Despite assertions in the past that a bailout was not necessary, Greece requested an emergency loan package from the International Monetary Fund (IMF) and its EU counterparts on April 23, 2010 amounting to EUR45 billion (US$60 billion) to stave off default. With Greece having a EUR 9 billion debt obligation due on May 19, 2010, it is important that the Country raises funds quickly for several reasons. Firstly, a default by a EU nation would have devastating effects on an already reeling Euro currency, raising further questions on the ability of 16 separate nations to share one currency. It is also likely to increase the cost of funds for all Euro nations, possibly resulting in higher taxes to mitigate some of the increased cost, stifling ongoing European stimulus efforts. A default would also inflict huge losses on banks that invested in Greek bonds, institutions still licking the wounds caused by the global credit crisis.

It is also in the best interest of the EU to act quickly while the problem remains largely in Greece. Greece can hardly be described as an economic powerhouse, therefore, the financial commitment required to save this particular EU member is relatively small, especially when weighed against the cost of not doing so. It is critical that the problem is addressed before it has sizeable effects on vulnerable economies in the EU that are larger. Spain, for instance, is roughly four times the size of that of Greece or Portugal. Should the contagion reach the point where Spain needs a bailout, it is unlikely that the EU would have the resources to do so, putting the entire EU in jeopardy.

Over the weekend EU members, along with the IMF, finalized a loan agreement that would provide EUR110 billion of support to Greece, more than double what was initially proposed and the largest-ever bailout assembled for a Country. EUR80 billion of the amount would come from EU nations, with the IMF providing the rest. Several nations were initially apprehensive about putting their taxpayers’ money at risk, most notably Germany, who is providing 28 per cent of the EU contribution. However, the necessity of such action in order to avert a much larger crisis is clear. It also forces Greece to meet some very strict and ambitious economic objectives, including massive expenditure cuts aimed at lowering its budget deficit to three per cent of GDP by the end of 2014.

Though this can be viewed as a significant moment in the history for the EU as it demonstrates the willingness of member nations to provide economic support to each other, it is still not the end of the story. Greece’s ability to meet the requirements is still up for debate, and little has been shared about the repercussions of any failure on the part of the Greeks. Furthermore, the extent to which the other PIIGS have been affected is still unclear. Nevertheless, this is a huge step towards containing the debt crisis in the Euro region, and possibly sends a signal that the EU, and the euro currency, is strong enough to withstand grave economic pressures.

Sean Robinson is an Equity Trader at Stocks & Securities Ltd. You can contact him at srobinson@sslinvest.com.