The spectre that haunts Europe

A bail-out for Greece will not be the end of the euro area’s fiscal troubles

AS FINANCE ministers from the European Union gathered in Brussels for a two-day “informal” summit on February 11th, there was only one topic on the agenda: how best to help Greece avoid defaulting on its debts while, at the same time, reassuring bond markets that other euro-area countries with big budget deficits, such as Ireland, Portugal and Spain, were still safe bets.

As The Economist went to press, only the basic elements of a possible backstop for Greece had emerged. Pride is at stake, so it will be a “European solution”, with the IMF limited to an advisory role. It will be a joint effort led by France and a somewhat reluctant Germany, the country with the deepest pockets. Berlin frets that a rescue will only encourage further profligacy.

Acting in concert limits the political fallout that comes from rescuing countries. It helps put pressure on Greece for more reforms and cuts in public spending as conditions of the bail-out. But the need for co-ordination makes it hard to act decisively, and leaves bond markets nervous. Funding will be limited, perhaps just enough to help Greece meet its immediate obligations (€20 billion of its debts fall due in April and May). Help may take the form of a guarantee on refinancing bonds or an outright purchase of those bonds by Greece’s rescuers.

There is talk that one reason to keep the IMF out is that its chief, Dominque Strauss-Kahn, may be a rival to President Nicolas Sarkozy in the French elections in 2012 (see article). If Europe snubs the IMF, it may eventually need to set up a clone—a European Monetary Fund—to deal with future funding crises. That idea has little support for now, it seems. The ad hoc response to the Greek crisis may partly reflect a fear that a formal set-up with a staff, budget and the ability to raise funds in capital markets would be too close to a fiscal union for many countries to stomach.

For some, the rescue of Greece marks a new wave of the global financial crisis. The first was about the solvency of banks; this one is about the solvency of sovereign countries. Yet Greece’s public-finance problems were brewing long before the rich world’s banks started to falter. When it joined the euro in 2001, its public debt was already more than 100% of GDP. Despite a long boom spurred by low interest rates inside the euro, Greece did little to tackle its persistent deficits.

After its new government admitted, last October, that its budget shortfall would be 13% of GDP, more than twice previous forecasts, Greece’s cost of borrowing started to pick up. Bond investors were further unnerved by the revelation that Greece’s debt had been understated by keeping unpaid bills off the books. With the country’s credibility shot, even the tough austerity programme announced earlier this month could not rally confidence.

Talk of a bail-out brought some calm to financial markets, though there is a risk that the lack of detail may trigger fresh paroxysms. The yield on ten-year Greek bonds fell below 6% the day before the EU gathering: in late January it had risen above 7%. The euro, which had been falling steadily against the dollar, perked up a bit.

Some euro-crats (and more than a few people in Greece) feel the euro zone has been picked on by speculators. They point out that its debt burden is no worse than in other parts of the rich world. The OECD reckons public debt in Britain and America will be higher than in the euro zone by 2011, as a proportion of GDP. The problem for the euro area is that it has trouble-spots, like Greece, with worse than average finances, and no means (until now) to tap the credit of their thriftier brethren.

Even that may be too kind a comparison. Bond investors have worried most about countries with big borrowing needs adding to an already high stock of debt. In future, they may fret more about the longer-term prospects for GDP growth. Sluggish economies cannot sustain a big debt burden for ever; and the euro-zone countries with the most bloated debt burdens also face severe obstacles to growth. Fixing public finances is just the beginning of a much-needed programme of reforms.
(Source: The Economist)