News Analysis

Thursday 18 September 2014

Colm McCarthy: EU's reluctant rescue package will prevent a Greek tragedy – for now

Kicking the can down the road is no good; only a full deal on debt relief will end the nightmare in Greece

Published 02/12/2012 | 05:00

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Tuesday night in Brussels saw the latest instalment in the Great Greek Rescue drama which commenced two-and-a-half years ago.

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Greece was patently insolvent in May 2010. European political leaders and the European Central Bank, against the advice of IMF officials, resisted the necessary decisions on debt restructuring. Greece had already accumulated unsustainable debts, since the economy had tanked, the deficit had soared and the banks were vulnerable.

Greece needed an immediate debt restructuring and the clear prospect of a successful exit from the mess created by Greek fiscal mismanagement. Instead, there was no debt relief: the funds lent to Greece went straight back out again to creditors of the Greek state and of the Greek banking system. This policy predictably ran out of road, resulting in a massive default of €100bn, the largest in history, on private holders of Greek sovereign bonds. But this second attempt at a resolution of the Greek crisis also failed, since the debt writedown was not enough.

Hence the third effort last week, which saw several manoeuvres designed to avoid an immediate financial collapse. More funds will be released by official lenders. There will be an extension of loan maturities and concessions on the interest rate. But two things are clear: the actions announced on Tuesday were reluctant and driven by the absence of an alternative. Greece was running out of cash. Moreover, there will be no decisive action to draw a line under the Greek debt crisis until the German election, scheduled for next September, is out of the way. This third deal to 'rescue' Greece will be followed in due course by a fourth.

Meanwhile, the Greek economy has weakened further and the government has little chance of achieving budget targets. Reform measures in areas like tax collection are overdue but cannot be expected to help in the short term. Only a full and final package of debt relief will bring the nightmare in Greece to an end.

The losses for lenders to Greece, as always in these circumstances, have already occurred and cannot be magicked away through pretending that Greek capacity to pay will suddenly begin to improve. The longer the crisis continues, the more that capacity will be impaired. About 70 per cent of total Greek sovereign debt is due to official lenders, including the eurozone rescue funds, eurozone governments, the IMF and the ECB. The pretence that these bodies cannot contemplate writedowns on their holdings of Greek debt lies at the heart of Tuesday's latest fudge.

One of the components in the fudge comes from the 'bonzer wheeze' school of international finance. About €30bn face value of Greek bonds remain in the hands of non-Greek private holders. They are worth only about €10bn at current market prices. The wheeze is to buy them back for €10bn and thus allow the Greeks to write off €20bn from the national debt. There are several snags with this approach. The first is that Greece does not have €10bn in cash, and no specific plans were announced on Tuesday to furnish this amount. Another risk is that the private holders (mainly hedge funds at this stage) might hold out for more, knowing that a writedown of official debt must come at some stage, at which point their bond values should rise. Significantly, the IMF's managing director, Christine Lagarde, hinted that successful execution of this debt buyback would be a requirement for continued IMF support, and this aspect of the deal has a December 13 deadline. The latest Greek deal, in other words, is not merely inadequate, it could unravel within a week or two.

The frustrations of the IMF with its adventures in Euroland have been unconcealed from the beginning. When the fund lends money to states unable to borrow elsewhere, it imposes strict conditions – for example, a requirement that the budget be brought back into balance fairly quickly. But it also insists on debt restructuring up front where that is needed, which means almost always. So the country getting IMF assistance receives an immediate reduction in the excessive debt burden which created the crisis in the first place, as well as interim financing for a few years. Legacy lenders to the state, and possibly the banks, get sizeable haircuts, enough to make the remaining debt sustainable. The country, suitably chastened by the experience, is given a decent chance of emerging from the crisis if it sticks to the agreed programme.

This is not what happened in Greece in May 2010. It was widely acknowledged at the time that economic prospects in Greece were so poor, and debt burdens so high, that it might not survive even if all the budget and policy reform conditions were met. Some of them were not met, but that is not why the Greek programme has failed repeatedly. The reason is that the Europeans were unwilling to do what needed to be done.

A feature of the policy response at European level has been the reliance on short-term and ad hoc measures tailored to the individual circumstances of each distressed eurozone member. Greece, Portugal and Ireland have already been excluded from normal access to the government bond market. Cyprus is in the process of finalising a rescue deal and Slovenia may be next. Most ominously, Spain and Italy are not quite out of the woods, having come close to disaster last summer. Each country, though, is being treated as a special case.

The 'special case' approach, articulated again in regard to Greece last week, is a denial that there is a systemic crisis across the eurozone deriving from weaknesses in the design of the single currency. The absence of political will to address the crisis at the European level results in the can getting another kick down the road under threat of an immediate crisis in each of the financially distressed countries.

The most recent concessions to Greece have given rise to expectations in Ireland and Portugal, the other two countries already in rescue programmes, that similar concessions, possibly involving delayed loan repayments and lower interest rates, will be offered to them. These expectations, in a familiar pattern, have been dampened down by spokespersons for some of the creditor countries, including Finland and the Netherlands.

There is scope for considerable fudging here, since the first (May 2010) Greek rescue was conducted on a different basis to the subsequent deals for Ireland and Portugal. It does not follow, either, that Tuesday's deal for Greece will be implemented without modification, or that it will have some simple and automatic read-across resulting in better terms for others. It will not, of course, be the final deal for Greece either. Even if implemented in full, as per Tuesday's communiqué, the Greek debt remains unsustainable given the prospects for the Greek economy.

The common currency project is a Franco-German political deal from the 1990s, which saw France support German reunification in exchange for German agreement to give up the Deutschmark and proceed to EMU, or Economic and Monetary Union. Unfortunately, not even a well-designed monetary union, never mind an economic union, emerged. The eurozone is just a currency union, lacking centralised oversight of the financial system and a central bank with full powers. It was vulnerable to budgetary excess, as in Greece, but also to banking bubbles, as in Spain and Ireland. Several EU member states refused to join, including Denmark and Sweden, and must now be feeling rather pleased with their decisions.

More importantly from Ireland's standpoint, the United Kingdom, Ireland's major trading partner, stayed out. In the mid-1990s, when the question of Irish membership was being discussed, proponents of entry, including former Taoiseach Bertie Ahern, dismissed concerns about British non-membership and the strains which that might impose on Ireland. He expressed the view, widely held at the time, that Britain would join in due course. That did not happen and there is very little prospect that it will ever happen now, given the debacle which has unfolded.

Instead, there is now a risk that the UK will detach itself more and more from the entire European integration project. The mess that Europe has made of monetary union has brought Euro-scepticism centre-stage in the UK.

In the long run, these developments could have greater implications for Ireland's relations with Europe than the immediate budgetary and financial crisis.

Sunday Independent

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