The top of the mind concern for the global investors today is the sovereign debt crisis in Europe. What had started as a problem in a few countries in Europe is slowly engulfing the whole of Europe. The markets are concerned with Portugal, Ireland, Greece and Spain?the so-called PIGS countries. They have unsustainable levels of fiscal deficit and government debt. The markets downgraded the European government bonds much before the rating agencies officially downgraded them. As usual, the rating agencies were behind the curve and were obviously criticised for their actions.

What is the genesis of this crisis? The European Union is a mix of countries with diverse aspirations and culture. They were united together to form an economic union with a common set of economic goals. Europe followed the socialistic model of governance to bring the disenfranchised Left-leaning portions of the population into the democratic mainstream. This resulted in many of the European countries spending an enormous amount of money in social welfare, resulting in a huge fiscal deficit and government debt. Since the EU had a common set of monetary norms to be achieved, some of the governments like Greece had deliberately misreported their country?s official economic statistics by undertaking certain complex off-balance sheet financial derivatives that could mask the real fiscal situation. When the economy was doing well, some of these excesses were ignored by the markets and successive governments enjoyed the ride. But the global financial crisis accentuated the problem as the growth levels came down and the fiscal situation reached alarming levels.

The European Commission estimates that the average deficit of the 16-nation euro region may rise to 6.6% of GDP this year from 6.3% in 2009. The overall government debt may surge to 88.5% of GDP in 2011 from 84.7% this year. Those debt and deficit figures are the highest since the introduction of the euro in 1999.

On the surface, the EU looks economically healthier as compared to the US, Britain and Japan. The deficit of US (both federal and states), Britain and Japan is 10.6%, 11.5% and 9%, respectively while their total sovereign debt at the end of 2009 was 70%, 68% and 200%. But, the Eurozone is not a single nation. It does not have the power to avert a sovereign debt by asking the central bank to monetise its debt, which will result in devaluation of the currency and increase inflation for all the countries in the EU. The countries in Eurozone don?t control the European Central Bank that can act independently to enforce debt discipline. If the ECB chooses to monetise one country?s debt, it then dilutes the value of euro and this will result in the ECB effectively spending the other country?s money without its explicit consent. Also, most of the debt of these European countries is held majorly by western banks, and the ECB?unlike the Fed in the US?does not have the flexibility to bailout troubled debtors.

Many people predict that the euro is unsustainable. But its end would certainly be good for some of the stronger economies in the Eurozone like Germany. But, this is a wishful thought as the European financial institutions are exposed to debt and deposits in every European country. If the Eurozone breaks apart and every country goes back to their national currency, then the weaker countries will have to massively devalue their currencies and the funds will move to countries with stronger fundamentals. This will also result in financial institutions of stronger countries being affected due to their exposures to debt of the weaker countries. This will create more chaos in those countries.

The way out for the European countries is to cut fiscal deficits massively by pruning social spending and reducing government debt aggressively in the years to come. This will result in a major revolt in the countries that are used to massive government subsidised social welfare spending.

The US financial crisis ended crony capitalism, while the European debt crisis will result in the end of socialist welfare societies. In one way, the current European crisis is similar to the Asian crisis in 1997. Asia took the pain and reduced its fiscal deficit. They devalued their currencies and exported their way out of the mess. Europe has to learn from this and take harder steps. This requires a generational mindset change, which is difficult to come forth in Europe.

?The author is the chief financial officer of Infosys Technologies Ltd