Spain and France feeling Greek euro contagion

Spain and France came under intense pressure from the European Commission on Friday to deepen their deficit cuts as anxiety mounted over Greece's ability to stay in the euro zone.
 
Last ditch efforts to form a Greek government after last Sunday's inclusive election ran into trouble and ratings agency Fitch said a Greek exit would damage all 17 euro zone countries and prompt it to review their credit ratings.
 
Presenting its twice-yearly economic forecasts, the European Commission said Spain would run a deficit of 6.4 percent of economic output this year and 6.3 percent next year, with both targets substantially above levels already agreed with the EU.
 
France, the eurozone's second largest economy, will also miss its 2013 budget deficit goal of 3 percent by a wide margin, the Commission said, meaning new President Francois Hollande will have to take swift action to cut spending and raise taxes.
 
Hollande said he had been aware for several weeks of a bigger deterioration in public finances than the outgoing government had admitted, and would await an audit by France's budget watchdog before "taking the necessary decisions".
 
Olli Rehn, the European commissioner for economic affairs, said he had full confidence in Spain's ability to meet its targets, but with the economy expected to contract this year and next - the worst outlook in the euro zone - and the country's banks being rescued at high cost, Madrid has its work cut out.
 
"This calls for a very firm grip to curb the excessive spending of regional governments," Rehn said at a news conference to present the macroeconomic forecasts for the EU's 27 countries, including the 17 that share the euro.
 
"For Spain, the key to restoring confidence and growth is to tackle the immediate fiscal and financial challenges with full determination," he said.
 
In Greece, the leader of the Democratic Left Fotis Kouvelis, appeared to dash hopes for the formation of a coalition government, following Sunday's inconclusive elections, saying he would not back any coalition that supports the 130-billion-euro EU/IMF bailout keeping Greece afloat.
 
Dutch Prime Minister Mark Rutte said that while he wanted Greece to remain in the euro area, the currency bloc would not fall apart if it left.
 
Fitch said that if Athens were to abandon the euro, the remaining countries could find their sovereign ratings at risk, a move that could potentially raise their borrowing costs.
 
The Greek impasse raises the likelihood of having to hold a new general election, probably on June 17. But there is no guarantee a second poll will produce a result with better prospects for forming the pro-bailout government that EU leaders want for the stability of the currency project.
 
The latest opinion polls show that the radical left coalition Syriza, which came second in Sunday's vote, could do even better in a new vote, potentially overtaking New Democracy, the conservative pro-bailout group that came first.
 
Such a result could tip Greece closer to leaving the currency zone, even though polls show 75-80 percent of the public, want to keep the euro but not the harsh EU/IMF bailout terms.
 
Banks in Europe and beyond have already begun quietly preparing for the possibility that Greece will have to reintroduce the drachma, the currency it gave up a decade ago when it joined the euro.
 
"The future of Greece in the euro zone lies in the hands of Greece," German Foreign Minister Guido Westerwelle told parliament in Berlin.
 
"Solidarity is not a one way street," he said.
 
BETTER IN THAN OUT?
 
European policymakers remain deeply concerned about the potential for Greece to cause problems and although Austria's finance minister said the region was now more insulated from the threat.
 
Contagion risks may have diminished, but the forecasts from the Commission suggest there are a host of deficit, growth and unemployment problems riddling economies beyond Greece, including Spain, Italy, Portugal and potentially France.
 
In rare bright spots, Rehn said Italy and Portugal were on track to meet their targets.
 
The Commission said it expected Spain's economy to contract 1.8 percent this year and a further 0.3 percent in 2013, leaving the country climbing a mountain if it is to reduce its budget deficit by a large margin and tackle 24 percent unemployment.
 
What's more, the country's major banks are in the midst of a capital restructuring that will see more than 180 billion euros of toxic assets moved into a 'bad bank' and potentially several dozen billion euros more.
 
"Spain stands out like a sore thumb," said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London.
 
"Not only does the Commission expect the recession to be more severe and protracted, the anticipated fiscal slippages are increasing, with no progress expected next year. This is the strongest indication yet that austerity is failing in Spain."
 
Madrid had promised the Commission it would cut the deficit to 5.3 percent this year and to 3.0 percent in 2013, and has already announced a series of measures to hit that goal, including raising valued added tax and cutting health spending.
 
The Commission's forecasts don't take into account upcoming adjustments, notably by the regions, but even when those are added it remains unlikely that Spain will meet its targets.
 
That has led some EU officials to suggest that Spain could be offered leeway, perhaps with its 2013 target of a 3.0 percent deficit being delayed by a year. However, Madrid itself has so far said it does not want any wiggle room or concessions.