Catch 22 for EU member states facing deficits

Predictions that 2010 will bring new and complex sovereign debt problems are rapidly proving to be correct. Yesterday, European Central Bank chief economist Jurgen Stark sent a stark warning to all European countries with bad public sector debt problems when he said there will be no bail-out for Greece, the first EU nation - but almost certainly not the last - to have its credit rating downgraded.

Stark said Greece's problems are entirely "home-made" and do not meet the terms required to trigger the rescue mechanism under EU treaty law. Greece's finance minister, George Papaconstantinou, retorted that his country wasn't expecting to be bailed out. Yet with Ireland, Spain, Portugal and Italy teetering close to a Greece-style downgrade, Stark's remarks will be duly noted.

But with no simple solution - EU member states can no longer devalue their currencies against the German Mark as they once would have - economists are warning that under-performing states are in a trap: they can neither borrow more nor sustain their public deficits. Currently the only solution appears to be dramatic - and massively unpopular - public sector cuts.

"Mass emigration would be a possibility, but surely not a recommendation," says the FT's Martin Wolf. "Mass immigration of
wealthy foreigners, to live in now-cheap properties, would be far better. At worst, a lengthy slump might be needed to grind out a reduction in nominal prices and wages."

The price of inaction is vividly on display in Iceland where President Grimsson's refusal to approve the deal to reimburse Britain and the Netherlands for a £3.6 billion loan made at the height of the banking crisis in 2008 threatens to plunge the country into renewed economic and political turmoil.

Grimsson claims he is living up to Iceland's traditions as one of the world's oldest democracies by referring the repayment plan to a national vote. Icelanders, who owe approximately $40,000 for each household, say they are being asked to foot the bill for mistakes of bankers and regulators and are being unfairly pressured to pay up.

"The UK and the Dutch have been pushing too hard and they have been using the IMF to pressure Iceland," former health minister Ogmundur Jonasson told the FT. "I am hoping now that they will respect democracy and understand that one has to listen to what the people say."

Underlying the dispute is disagreement in Iceland over plans to join the EU. The country needs to restore its financial credibility to be fast-tracked into the union, yet the widespread opposition to the debt plan has made uneasy allies of an irate majority with a right-wing minority opposed to EU membership.

And that's only a taste of how complicated it's going to get should more EU nations, aspiring member nations, or even awkward semi-participants like Britain, head toward ratings downgrades and debt defaults. ·