ANALYSIS:UNCERTAINTY ABOUT the Greek ability to implement its bail out programme, notwithstanding the abandonment of the referendum, is likely to continue to cause significant market worries.
But it is important to try to stand back from the current turmoil and to assess, in the wake of the broader Brussels deal last week, the underlying prospects for the rest of the euro zone, including this State.
Even before the latest act in Greece’s drama, the deal had met with mixed reactions in Dublin. Several commentators criticised the Irish Government for not having sought a debt write-down similar to Greece.
Others expressed scepticism that the broader effort to address the problems of vulnerable countries such as Italy would succeed.
The decision to impose a “voluntary haircut” on private debt was inevitable. Otherwise , total Greek debt by 2020 would still have been 160 per cent of gross domestic product.
No amount of intensified austerity, or wishful thinking about its future growth prospects, would have changed this unpleasant reality.
The International Monetary Fund is forbidden to lend into such an unsustainable debt situation, if only because it would later probably face repayment difficulties.
Some commentators have implied that if the Republic were to receive a write-down like that given Greece, somehow our life would be easier, but this is implausible. In truth the price the Greeks will have to pay for creditors’ acquiescence is unprecedented.
The Brussels communique spoke ominously of the need to “strengthen mechanisms of implementation”, IMF-Eurospeak for a deeply intrusive role for the international community in Greek affairs.
Truly, Greece will be a “ward of the court” for at least the next decade, with little prospect of any easing up on austerity.
Creditors will seek to exact a heavy price for seeing much of their debt written off, partly as a deterrent to others who might be tempted down the same path. (And if the Greek bailout had been rejected by a referendum vote, the short- to medium-term prospects outside the euro would surely have been worse.)
The Republic attaches a high priority to regaining its fiscal and economic sovereignty as quickly as possible.
While uncertainty surrounding the world economic outlook clouds the picture, there is a more than reasonable prospect that the debt could be managed. This State’s maximum projected debt to GDP ratio, at 110-115 per cent, is far from 160 per cent .
Nor does the Irish economy have the deep-rooted structural and “cultural” problems that Greece must address.
With luck, some time around 2013-14, the Government should be able to say to our friends from Washington and Brussels, “thank you and goodbye”.
Of course, this positive scenario could be upended if the broader euro debt problem is not addressed promptly. Here, the critics of last week’s deal may be on firmer ground.
Characterising the problem as one of “contagion” alone may be something of a misnomer since it implies the spread of a virus to an otherwise robust and healthy patient.
Apart from the risks to bail-out countries such as the Republic and Portugal, addressing the potentially much more worrying “fragile” cases of Italy and Spain (and even France) requires two things.
First, sufficient financial firepower to ward off what may be, in many instances, speculative attacks sparked by panic and overreaction in the markets.
Second, where there are underlying problems of debt sustainability, a mechanism to ensure these are addressed decisively is essential.
The summit package falls somewhat short on the first count and, at least so far, is not very convincing on the second.
The European Financial Stability Facility’s resources were increased to about €1 trillion, although given the scale of market financing of Italy and Spain (never mind France), many feel that about €2 trillion is needed.
Moreover, the additional financing partly involved creating an insurance fund to underwrite losses on new sovereign debt of up to 20 per cent. Besides raising many complex legal and technical issues, potential lenders may well come to believe that the risk of loss is greater than 20 per cent.
The facility is also to be augmented by tapping – to a greater degree than hitherto – enormous funds held by emerging market economies such as China.
These countries have a strong self-interest in preserving the euro, nor would they be at all averse, for broader political reasons, to be seen as riding to the rescue of mismanaged industrial economies. However the Chinese are hard-nosed and will insist on guarantees to ensure that they would be close to the top of the queue when it comes to getting repaid.
If, despite a certain embarrassment factor for the euro leadership, the big emerging economies can be persuaded to play a much greater funding role than envisaged, the facility’s financing problems could be greatly eased.
This is especially important since the fund’s integrity could come into question, if the credit standings of major contributing countries such as Italy, Spain and France were to start to come into question.
Apart though from trying to collect extra funds, intensified efforts to persuade vulnerable non-bailout countries to implement overdue reforms is at least as, if not more, important.
Throwing money at a problem provides only temporary respite and the willingness of, say, a China to contribute in a major way would depend on whether they sense that underlying debtor country problems are being tackled.
In this respect, it may be time to take a much tougher line, starting with Italy, especially since various undertakings given by Italian prime minister Silvio Berlusconi in return for earlier ECB bond market intervention were not adhered to.
Continuing confusion and policy disarray in Rome cannot engender confidence among potential lenders.
A more structured, formal effort, involving the IMF explicitly and with the financial backing of cash-rich emerging economies as a back stop, may be needed to persuade the Italian government to act decisively. Such a package could be labelled a “precautionary arrangement” rather than a bailout.
If, as a result of external insistence, those in favour of reform in Italy finally get to take the necessary measures, markets, as has happened to the Republic, will respond positively and the need for a massive bailout would be obviated.
The Republic is surely correct in not seeking to follow the same “voluntary default” route as Greece, but we, with the rest of the euro area, remain vulnerable. The stakes are high for the euro zone.
More far-reaching steps appear necessary to deal with the core problems of several key debtor countries.
Donal Donovan, a former staff member of the IMF (1977-2005), retiring as a deputy director, is adjunct professor at the University of Limerick and a visiting lecturer at Trinity College Dublin. Although he is a member of the Irish Fiscal Advisory Council, this article is written in his personal capacity.