COMMENT:With the Greek bailout clearly not working, Italy is an accident waiting to happen

THE ISSUES at play in Europe’s debt crisis – at EU, euro zone and national levels – are proliferating, creating enormous problems of co-ordination, on top of all the other issues that have prevented proportionate action being taken over the past two years.

Greece has yet again been at the centre of things. November will mark the second anniversary of the revelation that its public deficit and debt positions were far worse than had previously been admitted. That triggered the euro crisis. Fears of Greek default have been threatening the currency, the Continent’s financial system and its economic wellbeing ever since.

The emergency meeting of EU leaders in Brussels at the weekend, and a second one tomorrow, take place against the backdrop of a truly depressing analysis of Greece’s debt position, drawn up by the European Commission and circulated last Friday.

It effectively concedes that the bailout is not working. The proposal for a 21 per cent voluntary writedown of Greek public debt, agreed by EU leaders in another emergency summit just three months ago, will not come close to stabilising the situation, according to the commission’s analysis. Instead, it lays out a scenario in which 50-60 per cent of Greece’s sovereign debt is written off.

A write-off of that scale has implications for the Greek economy, its banking system, the capital base of the European Central Bank, the capital bases of all Europe’s banks exposed to Greek debt and – probably most important – the sovereign bond markets of Italy and Spain.

If clear plans are not in place to “firewall” these effects, Greek default is likely to cause the crisis to reach a point where nothing can be done to control it (and even if clear and credible plans are in place, it is still far from certain that such a default will not unleash uncontainable forces).

There has been some comment in Ireland in recent times to the effect that, if Greece defaults, Ireland should follow suit. This assumes there are no downsides to defaulting.

It is worth noting that the Greeks themselves are among the most ardent opponents of increasing the scale of the writedown on their sovereign debt.

They are opposed because of the balance of costs and benefits.

One cost is the impact on the Greek banking system. It is already profoundly weak and, because Greek banks have large holdings of Greek government bonds, a big writedown would push those banks into insolvency.

They would have to be recapitalised to prevent their collapse, something which could well be preceded by TV pictures flashing around the rest of the Continent of queues and scuffles, and possibly worse, outside Greek banks.

The cash to recapitalise Greek banks will almost certainly have to come from the EU’s bailout fund – the European Financial Stabilisation Facility. If that money is pumped directly into Greek banks, rather than lent to the Greek state first, it will amount to the first full-scale Europeanisation of the costs of a banking crisis in a member country.

Such a precedent would strengthen Ireland’s position on sharing the costs of bailing out bondholders in Irish banks.

Along with the Greek issue, there was much talk in Brussels over the weekend of boosting economic growth by implementing reforms that would allow markets to work more efficiently. Such liberalisation measures may put an economy on a firmer foundation in the long run, but the costs are taken up front (job losses, for instance) and the benefits are much more slow-burning (such as lower prices), if they materialise at all.

Greece’s nearest EU neighbour – Italy, another country in the spotlight – is a case in point. It has done a considerable amount to liberalise its labour market over more than a decade. This has helped boost the rate of job creation and lower unemployment, but has had limited effect on raising economic growth. Italy has been at or close to the bottom of the euro area growth league table since the single currency was launched.

Even the best designed and perfectly implemented reform plans cannot gaurantee economic growth.

But reforms have to be tried, if only to give a short-term boost to the almost non-existent credibility of the Italian government. With the second-highest debt levels in the euro zone, Italy has been an accident waiting to happen since the euro crisis erupted.

Along with reforms, perhaps the greatest credibility-enhancing measure Italy could take now would be to retire the prime minister, Silvio Berlusconi. Never someone taken seriously internationally, EU leaders displayed open derision towards their Italian counterpart in Brussels over the weekend.

The sooner Berlusconi departs, elections are called and a caretaker administration put in place of the kind which achieved considerable successes in the 1990s, the better for Italy and everyone else in the euro zone.