Hamish McRae: Europe's weakest states will be bailed out, but we'll all pay the price

This was a test for Greece but it has now become a test for the eurozone. It could become a test of the effectiveness of fiscal policy in helping pull the developed world out of recession.

The weakness of the country's finances has increased the cost of borrowing not only for Greece but also for other weak European countries, in particular Portugal and Spain. There is even a real possibility that the creditworthiness of the strong will suffer along with the weak, eventually damaging Germany and France. Inevitably there has been speculation that Greece will have to leave the eurozone. That possibility is hotly denied but the euro has slumped on the foreign exchange markets.

For the moment the European Commission has endorsed the country's stability plan but that has not been accepted by the markets – as the continuing fall of the euro shows. That is why Greece will if necessary be bailed out by the other eurozone countries, with Germany bearing the brunt of the burden. Timing is crucial. Greece needs help in repaying debts that fall due in the next three months. So it has to convince the lenders, the international markets, that it is cutting spending and increasing tax revenues by enough to get its deficit under control.

Meanwhile the focus has shifted. Neither Portugal nor Spain has EC approval for their fiscal measures. Both countries have minority governments and therefore will struggle to bring in austerity packages that will win EC approval. Their borrowing costs have risen and seem likely to rise further. This is particularly serious as both Portugal and Spain have to roll over 17 per cent of their National Debt this year. (France, which has much sounder finances, has to roll over 20 per cent of its debt this year.)

What we are seeing is widespread distrust in the ability of these countries to be able to service their debts. At a price the government of any developed country can always borrow money. But if the interest rate rises that increases the cost for all borrowers – including companies and people seeking fixed-rate mortgages – not just the government in question. That rise in borrowing cost offsets the boost that government borrowing gives to demand. The danger for the eurozone (and indeed the UK) is that unless confidence can be restored in the weaker counties, borrowing costs for everyone will rise in the months ahead.