Cracks Appear in Merkel’s Coalition as Debt Crisis Worsens

Fears that Greece is heading towards an inevitable default have increased significantly in the past two weeks. And now it appears that as the likelihood of a default increases, the fate of Greece has driven a wedge between the two main parties in Germany’s coalition government headed by Chancellor Angela Merkel.

On Tuesday, comments made by German Vice Chancellor Philip Roesler who heads the Free Democratic Party painted Merkel into a corner. Merkel, whose Christian Democratic Party leads the government only through the support of the FDP, was forced into damage control when Roesler brought up the possibility of Greece defaulting and being forced out of the Eurozone.

“To stabilize the euro, there can no longer be any taboos,” Roesler wrote in an article for the German Newspaper Die Welt. “That includes, if necessary, an orderly bankruptcy of Greece if the necessary instruments are available.”

Merkel immediately went on the offensive to reassure markets already in panic following Monday’s deep sell-off. Merkel pledged that she personally, and the government as a collective, are in agreement that “everything must be done to keep the euro area together”.

Merkel went on to suggest that the loss of Greece would lead to a “domino effect” that would soon engulf other debt-ridden countries within the region.

Greece Expected to Miss Deficit Target

One of the main conditions Greece agreed to in exchange for emergency funding was to reduce its 2011 deficit by 7.6 percent. Progress on this objective is currently being reviewed by representatives of the “troika” comprised of the European Union, the International Monetary Fund, and the European Central Bank. The preliminary results of this audit are not encouraging.

The latest evaluation is that Greece will fail to meet its deficit reduction target. According to the auditors, this failure is due partly to a lack of effort on the part of the government, but also because the Greek economy contracted more than had been anticipated. The weaker growth resulted in lower revenues leaving a wider-than-expected budget shortfall.

The big question now of course is will the government’s apparent failure to meet its deficit goal affect the next financial aid payment of 8 billion euros (US$10.9 billion)?

At this time, most analysts believe Greece will still receive the next tranche as scheduled but it will surely come with a stronger warning that Greece must take its deficit reduction goals more seriously.

In addition to the deficit shortcomings, Greek officials will also be taken to task over their lackluster efforts to privatize a series of government-owned agencies. Again, in exchange for emergency funding from its Eurozone neighbors, Athens was expected to sell a series of government-owned agencies and use the money to reduce the operational deficit.

The scheme is expected to raise 1.7 billion euros (US$2.3 billion) by the end of the month, and another 5 billion euros (US$6.8 billion) prior to the new year. Publically, the government claims it is optimistic that it will meet these targets but the troika remains unconvinced.

It is commendable that Merkel acted so quickly to defuse the comments of her Vice Chancellor but in the end, this may prove to be little more than window-dressing. Greece is clearly not on track to contain its deficit and the likelihood of a default – no matter what Merkel says – is higher today than it was just two weeks ago.

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