An anti-austerity backlash by voters in Greece and France shook the euro zone on Monday, causing jitters for the euro currency and stock markets amid deepening doubts about whether Greece has a future in the single currency area.
Greece, where Europe's sovereign debt crisis began in 2009, plunged into turmoil after elections boosted far-left and far-right splinter groups, stripping mainstream parties that back a painful EU-IMF bailout of their parliamentary majority. That raised questions over whether the country could avert bankruptcy and stay in the euro as Antonis Samaras, leader of the conservative New Democracy party which won the biggest share of the vote, struggled to cobble together a government. Samaras, who has three days to try to form a coalition, called for a national unity government to keep Greece in the euro zone but renegotiate the bailout programme.
The shock Greek result overshadowed France's presidential election, in which Socialist Francois Hollande, who wants to change Europe's policy focus from austerity to restoring growth, ousted conservative incumbent Nicolas Sarkozy.
German Chancellor Angela Merkel, who had openly supported Sarkozy, her partner in euro zone crisis management, pledged to welcome Hollande "with open arms" and work with him to maintain strong Franco-German cooperation at the heart of Europe. But she also made clear there could be no renegotiation of a fiscal discipline treaty. Hollande has said France will not ratify it unless it is augmented with growth-promoting measures. "We in Germany are of the opinion, and so am I personally, that the fiscal pact is not negotiable. It has been negotiated and has been signed by 25 countries," Merkel told journalists. "We are in the middle of a debate to which France, of course, under its new president will bring its own emphasis. But we are talking about two sides of the same coin - progress is only achievable via solid finances plus growth."
The euro fell to a three-month low of $1.2955 in Asia before recovering trade at around $1.3050 at 1600 GMT. European stocks slipped early in the day but most recovered later. French debt was spared from the selloff, in a sign that markets are more relaxed about the moderate Hollande. In US, stocks declined on Monday as investors had a muted reaction to European election results. The Dow Jones industrial average dropped 28.08 points, or 0.22 per cent, to 13,010.19. The S&P's 500 Index shed 0.06 of a point, or unchanged on a per centage basis, to 1,369.04. The Nasdaq Composite Index dipped 1.79 points, or 0.06 per cent, to 2,954.55.
International Monetary Fund Managing Director Christine Lagarde called on developed nations to push through "gradual" fiscal cuts. "Austerity versus growth is very much the debate of the hour," Lagarde said today at the University of Zurich, Switzerland. "I would argue it is not 'either/or.' We can design a strategy that is good for today and good for tomorrow."
While fiscal adjustment "is essential" and requires governments to lay out a plan for reducing debt in the medium run, "we know that fiscal austerity holds back growth, and the effects are worse in downturns," Lagarde said.
The yield on French 10-year bonds fell to its lowest in seven months.
In Greece, Sunday's election threatened to produce what daily Ta Nea called a "Nightmare of ungovernability". Among the parties that stormed into parliament were the extreme right-wing Golden Dawn, which won 6.97 per cent and 21 seats.
The hardline Left Coalition, opposed to the austerity programme, overtook the former ruling PASOK Socialist party in second place. Between them, New Democracy and PASOK won 149 of the 300 seats, two short of an overall majority.
Greece had appeared to have averted a disorderly default and euro exit in December when a government led by former central banker Lucas Papademos, and supported by the three main parties, agreed on a second international bailout under which private bondholders accepted sharp write-downs on their holdings.
But the four straight years of recession, wage and pension cuts and still rising mass unemployment drove angry Greeks to the political extremes.
Greece consistently missed targets under its first programme, agreed in April 2010, which led to the restructuring of its private-sector debt under the second package.
Officials say any further backsliding now will not be tolerated, especially with the International Monetary Fund a reluctant partner in the second programme.
Three Greek finance ministry officials told Reuters the country might run out of cash by end-June if it does not have a government in place to negotiate the next tranche of EU/IMF aid and projected state revenues fall short.
Euro zone leaders have so far done everything to avoid a Greek default and departure from the euro, which Merkel has said would be a catastrophe. Officials are worried by the precedent it could set for other troubled south European countries.
But public support for further bailouts is wearing thin in the euro zone's triple-A rated lenders Germany, the Netherlands and Finland, raising doubts about their willingness to go on supporting a recalcitrant Greece.
Some European diplomats and economists have been predicting the possibility of Greece leaving the euro area for months.
In a research paper published on Feb. 6, Willem Buiter, the chief economist at Citi, raised his estimate of the likelihood of Greece dropping out of the currency zone to 50 per cent over the next 18 months, from 25-30 per cent previously. On Monday, Citi raised the probability again to 50-75 per cent.
While the prospect once raised fears of a major systemic threat to the single currency area, concern has eased since a March debt swap substantially reduced private creditors' Greek exposure and euro zone governments and the IMF put in place increased financial firewalls to shield other countries.
But the reputational damage to the European Union and its currency, and the contagion risk, could be severe.
Zsolt Darvas, an expert economist on the euro zone crisis at Brussels think-tank Bruegel said he saw a one-in-three chance of an unstable government being created in Greece.
"Such a government may stop servicing the country's debt, including that (owed to) EU states. That would likely end the Greek membership of the euro zone," Darvas told Reuters.
"That would be horrible for Greece, with bank runs as well as massive personal and corporate defaults. The question then would be who could be next. How would the situation be resolved in Portugal and Ireland?"
