“We’re at a critical point” in Europe’s debt crisis, said Olli Rehn, the European Commissioner for monetary affairs. This week Greece’s prime minister, George Papandreou, staved off a sovereign default by winning a vote of confidence with a margin of 12 votes. Next week, parliament will vote on a fresh round of austerity measures, including a privatisation programme, and will have to approve the legislation needed to implement them.
Only then will the European Union and the International Monetary Fund release €12bn, the next tranche of last year’s €110bn rescue package. Without this, Greece will run out of money by mid-July. Europe is also working on a new bail-out for Greece, worth around €100bn, which is expected to take a month or so to hammer out.
What the commentators said
One element of the second rescue package remains “vague and formless”, as one US source told the BBC’s Robert Peston. In order to alleviate the burden on Europe’s taxpayers, policymakers are hoping that private investors will agree to a ‘voluntary rollover’ of their Greek debt, whereby they buy more bonds with the money they receive when their current bonds mature. The flaw in the plan is that there’s no reason “why anybody would roll over a Greek bond if they had a choice”, said Gary Jenkins of Evolution Securities. A Greek bankruptcy looks inevitable, so no investor would want to risk a future loss, and ratings agencies have in any case dashed policymakers’ hopes that a rollover would not technically be a form of default.
Greece has a debt pile worth 150% of GDP, growth forecasts are negative and interest costs are spiralling. So to assume it can ever get its finances under control “is to accept Alice in Wonderland economics”, says Allister Heath in City AM. Interest costs are now so high that “any attempt to achieve a balanced budget would kill demand… undermine tax receipts and cause more political and social upheaval”, added Nils Pratley in The Guardian. Eurozone leaders have been in denial: “Greek default is coming one way or another.”
But a sudden and disorderly Greek default, as one fund manager put it, “could make Lehman look like a tea party”. Bank losses would rocket as other peripheral states’ bonds tanked and yields soared, possibly prompting further sovereign defaults. Banks would also have to pay out on credit default swaps (insurance against a Greek default). US money-market funds have $360bn of short-term European bank debt, said Agnes T Crane on Breakingviews.That’s another “transatlantic channel” for contagion to spread. The panic could freeze lending as banks stop trusting each other, as occurred three years ago. A eurozone exit by a bankrupt peripheral state would cause further upheaval.
Yet another bail-out, however, will just increase our eventual losses on Greek debt since it can never escape its debt trap. According to the think tank Open Europe, another bail-out of around e120bn would raise the share of Greek debt underwritten by foreign taxpayers (via the EU, the European Central Bank and the IMF) from 26% to 64% in 2014.
So Europe urgently needs to develop a plan to prevent contagion in the event of a Greek default, said Pratley. The most urgent task is to recapitalise the still-weak European banking system so that markets will be more confident that it can bear the losses. A “managed, organised default”, with temporary assistance and a “plan to show how other countries will be dealt with” will be hard to organise and could still cause contagion, but it’s the best bet, said Heath. It will have to include a blueprint for leaving the euro so Greece can restore its competitiveness, he reckoned. The other options are a default now or an even bigger one at some point in the future. “There is no good solution.”
But time for the least-worst solution may be running out. It may not be long before constant protests ensure that Greece – and perhaps other peripheral states – give up on harsh cost-cutting. “There is every sign,” said James Marshall of FxPro.com, “that Greece’s appetite for further austerity has totally evaporated.” Europe’s debt crisis, concluded The Wall Street Journal’s Paul Hannon, is like “a slow-motion car crash”.