Greek debt crisis tests euro zone credibility

At stake is whether the 16 countries that share the European Union's currency can make a wayward member with a weak economy take drastic measures to cut its budget deficit without calling in the International Monetary Fund or sparking a social revolt.

This will involve an unprecedented level of EU tutelage over a sovereign state's finances, but without the IMF's leverage of disbursing or withholding loans in tranches.

Europe's policy instruments are blunter and would be economically harmful to apply.

Unless Athens takes swift action to slash spending and raise revenue, it risks costly EU sanctions and further downgrades by credit ratings agencies that would sharply raise its borrowing costs and deepen its economic recession.

EU officials say Greece has only itself to blame.

The country cheated its way into the euro in 2001 by fiddling its statistics and failed to curb its budget shortfall in the boom years. It will have the highest debt level as a proportion of economic output in the euro zone this year.

Years of concealment led to last October's admission by the newly elected Socialist government that the 2009 deficit would be a stunning 12.7 percent of gross domestic product, more than twice the level forecast by its conservative predecessor.

“Because of the history, there is not much sympathy out there for Greece,” said a European Commission official involved in the drive to enforce fiscal discipline. “There is a very strong determination to apply the rules.”

Prime Minister George Papandreou has promised to bring the deficit down to the EU ceiling of 3 percent of GDP in 2012, starting with a giant cut of four percentage points this year.

But financial markets and many EU officials don't believe he can achieve that based on budget plans announced so far and are pressuring Athens to make deeper spending cuts.

The government is due to submit a new three-year fiscal plan to the European Commission this month and EU finance ministers are likely to issue a virtual ultimatum in mid-February giving Greece four months to take corrective action or face sanctions.

Papandreou has so far rejected market pressure to cut public sector wages and pensions, which he fears would trigger social unrest in a country with a tradition of violent protest.

The government has said it will propose a pensions reform to parliament in April and a corrective budget if needed.

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