Our immediate fate hangs on one simple question: Can govts manage their debts?

So far the European debt crisis has resisted all attempts at a solution, with neither bailout schemes nor a leverage system appearing to have worked. Instead, the debt contagion is spreading from one country to another, destroying investor confidence and also pushing the cost of funding many European countries higher. 

The credit rating of European countries such as Spain, Portugal, Greece and Belgium was downgraded, and some are at risk of defaulting. Reacting to the situation, the European Central Bank attempted to restore market confidence by buying euro-zone bonds in order to lower their yields. 

Recently, the International Monetary Fund approved a set of reforms to increase the flexibility and scope of its liquidity provision and emergency assistance. Under the reforms, the Precautionary Credit Line was replaced with the more flexible Precautionary and Liquidity Line, which can be used in broader circumstances, including as a short-term liquidity window during times of heightened regional or global stress. 

Furthermore, it was reported last Friday that the IMF is preparing a ¤400-600 billion loan to Italy, which would allow the new government to implement structural reforms without having to roll debt over in the markets. Because the Italian economy is the third largest in Europe, any default would have severe consequences for the euro-zone financial system.

A similar picture afflicts the US, where the so-called super committee of Democrat and Republican members failed in its efforts to plan a $1.2-trillion deficit reduction over the next 10 years but saw the country maintain its credit rating following a last-minute agreement on August 2 to increase the US debt ceiling by $900 billion to around $16 trillion. This sparked doubt in investors over the ability of US politicians to bring into legislation the stimulus measures which are required to avoid considerable fiscal tightening. Failure to do this would have a noticeable impact on US economic outlook for next year.   

Even though managing their balance sheets is an incredibly tough task for countries right now, the attempts to do so will last for as long as it takes to get the debt crisis under control. Another 12 months of grappling with this globally problematic issue awaits, with 2012 just around the corner.

 

Duangkamon Phunkaew is asenior dealer at Bangkok Bank.