Next few months will seal fate of €1trn debt package
THE early indications are in rising shares, falling bond yields, and a strengthening euro -- but can the euro debt package agreed on yesterday morning last the pace?
Most market players agree that the latest package should calm the eurozone debt woes for now, but opinion was far more mixed about whether the package puts a permanent end to the crisis.
On the optimistic side there are grounds for believing it can for the following reasons:
•Europe as a whole does not have a crippling debt problem; the debt woes are mainly confined to the southern periphery of the eurozone. Overall debt levels are not out of control, with the euro area only having a budget deficit of 4.2pc -- just above the limits allowed under the Stability and Growth Pact. If the problems in Greece, Portugal, Ireland and Italy can be dealt with, the so-called "core'' of Europe should be able to pull the entire bloc out of the current debt mire.
•A Greek default can now happen in an orderly fashion, whereas a few months ago it looked like Greece could simply unilaterally declare it was no longer going to repay international investors, Latin American-style. The latest package is likely to make a Greek default less important in the sense that banks across Europe will bring their capital levels up significantly, leaving them at least better protected than a year ago from a Greek debt default.
•The deal also resembles the Troubled Asset Relief Programme (TARP) agreed in the US in October 2008. The resemblance arises in the sense that the TARP package was originally going to cost $700bn, but eventually came nowhere near that. What TARP did and what the EFSF expansion should do is provide confidence that no matter how serious any debt crisis gets, there will always be sufficient funds to cope with it among official sources.
Equally the early reaction to the package may be misleading and things could yet get worse for the following reasons:
•Many market analysts believe that Greece's debts are still too large, even after the controlled default agreed with the banks this week. Greek debt will still stand at over 100pc of GDP after losses are imposed on banks. That is still a very large debt burden, meaning that Greece leaving the eurozone still cannot be ruled out.
•Despite the partial fix for Greece, problems remain for other countries and in particular Italy where the debt burden concerns the bond market. A deep slowing of economic growth makes these debt problems bigger and the markets may still not want to fund these type of countries.
•Many economists, including Nouriel Roubini, still claimed yesterday the €1 trillion in the fund will not be enough. If some of the countries that are guaranteeing the funds in this expanded EFSF, such as France, lose their AAA ratings, the fund itself could start to fracture or be regarded as inadequate.