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Risk Rises of Dutch Government Collapse

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Marc Chandler

NEW YORK ( BBH FX Strategy) -- The Dutch government nearly collapsed Wednesday as efforts to find more savings to reach its deficit targets are causing nearly unbearable strains on the fragile coalition.

However, highly secretive negotiations are resuming Thursday as there is little alternative shy of new elections.

Recall the sequence of events. A key government agency warned of a budget overshoot for 2013 early in March. Rather than reach the EU-mandated deficit target of 3% of GDP, it now looks like 4.6%. This forced the coalition to begin negotiating a solution.

Liberal Prime Minister Mark Rutte seems eager to deliver new savings.

Several areas of reforms have been suggested. In housing, some in Rutte's coalition want to limit the deductions for mortgage interest payments. (These tax incentives help explain why the Netherlands has the highest level of mortgage debt in the eurozone.) There are also proposals to increase the copayment on health services. Other proposals involve the reduction of unemployment insurance from the current maximum of more than three years.

The problem is that Rutte's coalition partner, Geert Wilders' Party for Freedom, is loath to make social spending cuts that would hurt the party's members. His constituents are more sympathetic to cutting foreign aid, which stands near 0.7% of GDP and is a point of national pride.

Last week an MP in the Party for Freedom quit the party and left the government without a majority, though the MP says he will continue to support the government.

We first brought these issues to your attention on March 6. Since then, the Dutch bonds underperformed German bunds, leading to a modest widening of the spread from about 45 basis points to about 60 basis points. Another measure of the pressure that can be found in the credit default swap market. The price of insuring Dutch sovereign exposure has risen more than 20% to 121.5 basis points (five-year).

Pressure on the government will increase if the economic data warn of a deeper economic downturn this year. Next week features the March CPI. Base effects point to a drop in the year-over-year rate, which was 2.9% in February. In recent months, Dutch inflation has appeared a bit stickier than in Germany. Real sector data is not out until the following week, with industrial output, retail sales, consumer spending and trade figures.

One of our thematic points for the second quarter is the increased importance of political factors for the investment climate. Dutch developments are consistent with this, and the risk that the government collapses is rising.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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