Eurozone: Last-minute rescue package

The package does little or nothing to reduce the unsustainable debt mountain or stimulate economic growth

The last-minute rescue package put together by eurozone leaders on 21 July has averted an immediate Greek debt crisis. A default by Greece would have triggered a European financial crisis, with world-wide repercussions. The package, however, merely eases the Greek government’s cash-flow problem. It does little or nothing to reduce the unsustainable debt mountain or stimulate economic growth. While the eurozone leaders are heading for the beaches or the mountains, Greek workers continue to labour under the yoke of intolerable austerity measures.

The package provides another €109bn ($156.6bn, £96bn) in emergency loans for Greece for 2010-14 (following last year’s €110bn package). At the same time, the agreement reduced interest rates on these loans to 3.5% (down from 4-5% or higher). The maturities of loans have also been extended from seven years to a minimum of 15 years. This measure, which also applies to Portugal and Ireland, will improve the liquidity position, although it only marginally reduces the mountain of debt.

The 21 July deal will reduce Greek debt by just over 20%, according to estimates. This means that the national debt will peak at 148% rather than 172%. In other words, the national debt will remain unsustainable in the longer run.

The package also includes so-called private sector involvement, in the form of a voluntary ‘haircut’ for the banks which hold Greek government bonds. (A ‘haircut’ means a reduction in the face value of bonds and/or a delay in repayment.)

While this will make a very marginal difference to the debt position, it is a political victory for Angela Merkel, who can present it as a fig-leaf when seeking parliamentary support for the package in Germany. The deal also includes the extension of the powers of the EFSF (European Financial Stability Facility, created at the onset of the debt crisis last year). With the backing of the eurozone governments, the EFSF will guarantee Greek government bonds. However, there is no increase at the moment in the funds available to the EFSF (currently €440bn).

The deal also includes provision for €28bn proceeds from the privatisation of state-owned companies and land, which many commentators believe to be unachievable. The periodic disbursement of eurozone funds to Greece, moreover, will still be conditional on the implementation of draconian austerity measures in Greece. According to current plans, the Greek government has to achieve an annual budget surplus of around 5% of GDP from 2015 to 2020 in order to reduce the national debt to 120% of GDP. However, “one obvious danger is that Greece’s weak and uncompetitive economy is unable to return to growth, making it impossible for Athens to achieve its fiscal targets”. (Ralph Atkins, Financial Times, 27 July)

The original draft of the 21 July statement referred to a ‘Marshall Plan’ for the reconstruction of the heavily indebted eurozone countries. However, there is nothing in the package resembling the massive US-financed Marshall Plan of 1948-51, and this reference was dropped from the final communiqué. In addition to other measures, the deal holds out the possibility of another €17bn of EU structural funds for Greece (which will no doubt be subject to agreement by EU governments).

Private sector ‘haircut’?

Jean-Claude Trichet, head of the European Central Bank, has strongly opposed private sector involvement, on the grounds that it would be regarded as a partial default by financial markets. Moreover, the majority of the ECB directors believed it could set a dangerous precedent, with demands coming for similar haircuts in Ireland and Portugal, and even in Spain and Italy. However, Merkel was determined to secure a private sector contribution, necessary in order for her to get the approval of the German parliament. Public opinion in Germany is strongly opposed to the bailout of ‘profligate’ southern European countries like Greece, even though large chunks of Greek debt are held by German banks, which will therefore be among the main beneficiaries of the new bail-out package.

The ‘haircut’, that is the reduction in the face value of Greek government bonds, will only be 20%, which is better than the 40% reduction already effected in the secondary bond market. Maturities will be extended, so bondholders will have to wait longer for the return of their cash. However, the deal has the big advantage for the bondholders that the bonds will now be guaranteed by the eurozone governments (through the EFSF).

The private sector bondholders (mainly big banks and insurance companies) will contribute around €37bn to the Greek package during 2011-14. However, their losses on the deal will actually be around €54bn (with €16.8bn being contributed to an insurance fund to guarantee Greek government bonds). The €37bn that will actually be paid to the Greek government is tiny when compared to the total €350bn national debt.

The EU leaders claim that around 90% of bondholders will agree to participate in this deal, but that seems far from certain. The big institutional bondholders appear to be divided. Some have welcomed the deal as a guarantee against a Greek government default in which they would lose all their money. Others are clearly sceptical about the effectiveness of the deal, and fear that there will be further write-downs of the value of Greek government bonds. They also fear ‘contagion’, the spread of the fiscal crisis to Portugal and Ireland, and the much bigger Spain and Italy.

The EFSF is advancing €20bn for recapitalising shaky Greek banks. Meanwhile, the Greek finance minister is appealing to wealthy Greeks to repatriate the estimated €15bn that they moved abroad since the crisis erupted last year.

The role of the ECB

Trichet lost the battle to exclude private sector involvement – i.e. bondholders’ haircuts – from the new emergency package. However, the ECB won the battle to pass responsibility for intervention to the eurozone governments and the EFSF. When the sovereign debt crisis erupted in May 2010, the ECB began buying government bonds to prevent a collapse of the bond market. This has resulted in the ECB piling up billions of euros of bonds of shaky governments such as Greece, Ireland and Portugal. The ECB has also accepted billions of euros of government bonds as collateral for loans to the Greek government and other heavily indebted governments.

A haircut therefore means losses for the ECB itself, and a total default could provoke a major crisis for the ECB. Trichet wants to sell Greek and other government bonds to the EFSF, withdraw from responsibility for bailouts, and concentrate on eurozone monetary policy. However, only the ECB, which has the powers to create new credit, has the power to support European financial markets on a big enough scale in the event of a major crisis.

A bigger role for the EFSF?

The 21 July agreement expands the role of the EFSF. It will be allowed to buy government bonds on the secondary bond market (to support the price of bonds). It will also be able to buy bonds from the ECB, a concession to Trichet.

It will have powers to intervene pre-emptively, to provide emergency funds to eurozone governments to prevent a collapse of their bonds. The EFSF will also be able to intervene to recapitalise floundering banks, and in fact will be responsible for providing €20bn to troubled banks currently holding Greek bonds. The role envisaged for the EFSF, if actually developed, would resemble that of the International Monetary Fund on an international level. The move has been hailed as a “significant step towards Europeanisation of sovereign debt”. On the basis of its enhanced role, the EFSF would have more power to supervise the budgets and tax policy of eurozone governments, a step (at least on paper) towards economic federalisation in the eurozone.

However, the 21 July agreement does not allocate additional funds to the EFSF (which remain at €440bn). In reality, there are still severe limits on its powers. For instance, the EFSF will only be allowed to buy government bonds with the approval of the ECB. Intervention to recapitalise banks and support government finances will require the approval of the ECB and all national governments. In other words, any government could veto such an intervention.

The combined sovereign debt of Italy and Spain, for instance, comes to around €2,200bn. How could the EFSF possibly guarantee such a huge debt on the basis of its current funding? Nicolas Sarkozy’s claim that the 21 July deal represents a major change – pointing towards a ‘quantum leap’ in federalisation – is clearly premature.

Prospects?

The new package has averted an immediate collapse of the Greek government finances. However, the continued enforcement of drastic austerity measures is prolonging the slump in the Greek economy. Without growth, there is no way that Greece can escape from its debt crisis. Writing in the Financial Times, Gideon Rachman comments (25 July): “While the fear of sudden collapse has receded for now, the threat of a slow squeeze, crushing the Greek economy and causing social and political turmoil, is still very much alive.” The country’s future, he says, promises “blood, sweat and teargas”.

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