Financial contagion refers to the transfer of a financial shock in one country to other interdependent countries, which in this case is the wider euro zone area.
Stop the spread
Olli Rehn, European Monetary Affairs Commissioner, said that it was vital to stop the crisis spreading beyond Greece.
“It’s absolutely essential to contain the bushfire in Greece so that it will not become a forest fire and a threat to financial stability for the European Union and its economy as a whole,” Rehn said.
Three people burned to deathwhen protesters set a central Athens bank ablaze on Wednesday during a demonstration against austerity measures that are the price of the 110bn euro ($146.5bn) EU/IMF bailout for Greece agreed on Sunday.
Battered Greek bank shares shed a further 5 per cent on news of the fire deaths – the first casualties in three months of sporadic strikes and street protests.
This came as Moody’s, an international ratings agency, warned that it would downgrade Portugal’s sovereign debt within three months.
Moody’s said it had placed Portugal’s Aa2 government bond ratings “on review for possible downgrade” and it affirmed the country’s short-term rating.
Standard & Poor’s, another ratings agency, downgraded Portugal’s credit rating a week ago over similar concerns about fiscal and economic weaknesses.
Shares in Portugal and Spain, seen as the next two targets for investors testing the EU’s will and ability to defend weak euro zone economies, fell for a second day.
Portugal had to pay more than four times its previous yield to sell six-month treasury bills at auction on Wednesday.
The head of the International Monetary Fund acknowledged the risk of the crisis spreading from Greece to other EU countries but said he saw no real threat to the big euro zone states such as France and Germany.
“There is always a risk of contagion,” Dominique Strauss-Kahn told French daily Le Parisien.
“Portugal has been mentioned, but it is already taking measures and the other countries are in a much more solid situation … but we should remain vigilant.”
Europe at stake
Angela Merkel, the German Chancellor, said that Europe’s fate was at stake in the most serious crisis of the single currency’s 11-year lifetime, and other countries could be hit unless the rescue for Greece succeeds.
Without the aid, a chain reaction threatened to destabilise the European and international financial system, Merkel said in a debate on approving Berlin’s 22bn euro contribution to the emergency loans despite German public hostility.
Strauss-Kahn criticised the 15 other euro zone governments for charging Greece a 5 per cent interest rate on the loans, largely at Germany’s insistence, saying they should have lent at the same rate as the IMF, more than half a point less.
He also said that the deficit levels of all EU states were “worryingly high”.
But despite official denials, many economists are convinced Greece will have to restructure its debt, making private investors take a share of the pain.
“What we are seeing today is very classical financial contagion effect,” Sebastian Barbe, from Credit Agricole in Hong Kong, said.
Concern that Greece’s Socialist government will be unable to implement all the austerity measures because of potential social unrest is one of the drivers of the euro zone turmoil.
George Papandreou, the Greek PM, presented an austerity bill to parliament which foresees 30bn euros in new savings through cuts in wages and pensions and a hike in sales tax.
So far, demonstrations have been limited to tens of thousands but anger is mounting, with opinion polls showing ordinary Greeks believe they are paying the price of the crisis while tax evasion and corruption go unpunished.
“With our strike today we are continuing our fight against harsh and unfair measures that hit workers, pensioners and the unemployed,” Yannios Panagopoulos, president of private sector union GSEE, said.