ANALYSIS:AFTER TWO weeks during which Europe slid ever closer to the edge of the precipice, conscious and deliberate steps back were taken on Thursday night by EU leaders. As a result, there were some signs of stabilisation yesterday. Europe, and indeed the world, can breathe a sigh of relief.
It is to be hoped sincerely that the measures agreed mark a permanent turning point. Unfortunately, that is unlikely to be the case. But before exploring the reasons for that conclusion, the multiple positives in Thursday night’s package should be welcomed.
For the bailout three – Ireland, Greece and Portugal – less onerous repayment terms on rescue loans were granted. The cut in Ireland’s interest rate was doubly welcome. It lowers debt-servicing costs, and with it the risk of default. But it also signals the effective end of France’s campaign to have Ireland raise its corporation tax rate. If the only commitment Ireland has given in return is to sit at the table and listen to the unending and always fruitless discussion on an EU-wide consolidated corporation tax base, then there is little to be worried about.
Nor should the interest rate concession be understated, whatever its size in cash terms. Ireland, and the other two recipients, will be given money at lower rates than can be raised by many euro zone countries which have not been bailed out, including Spain and Italy.
Much of Thursday’s package was devoted to Greece. It is now set to become the first developed country to default since the 1950s. While this may well have negative consequences for it in the medium to very long term, having a part of its huge debt effectively forgiven is likely to aid it in the short term.
What impact this will have on the wider market for euro zone government debt remains to be seen, but the signs thus far have been broadly positive. The bond yields of all five peripherals ended the week well below their starting levels, despite the rumours, confirmed on Thursday night, that holders of Greek bonds would suffer losses.
If, in the weeks ahead, there are no negative knock-on effects from the Greek default on the wider European sovereign debt market, the case for Ireland not repaying unguaranteed senior bank bonds in the non-core banks will be strengthened.
The sole justification for bailing out bank bondholders to date has been that the collateral damage – to Ireland and the euro zone more widely – would likely outweigh the savings to Irish taxpayers. If holders of Greek sovereign debt can take a hit without causing collateral damage to that market then why would haircuts for Irish senior bank bondholders disrupt that huge market?
The case is simple: markets priced in a Greek sovereign default. That is what they have got. They haven’t panicked. Markets are pricing in an even larger risk of default on senior Irish bank debt. Why would they panic if default is what they get?
Another positive from Thursday’s package is the widened scope of the main bailout fund, the Luxembourg-based European Financial Stability Facility (EFSF). This is now emerging as a major institutional innovation in the architecture of the EU. It is potentially an embryonic euro zone finance ministry – a fiscal authority to complement the zone’s monetary authority in Frankfurt.
If the euro is to survive in the long term, it is likely that such an institutional innovation will be unavoidable.
But there are also reasons for concern if this goes ahead on its current trajectory. While talk of a democratic deficit in the EU is usually misguided (checks and balances, both formal and informal, on EU member countries and institutions have historically been numerous and strong), the powers flowing to the stabilisation facility, like the crisis-era powers exercised by the European Central Bank, do not appear to be subject to sufficient democratic balance and check.
If the EFSF has been given unaccountable power on Thursday, it was not given enough new money. The decision not to add to its resources signals that member countries are unwilling to put their money where their mouths are when it comes to doing everything to save the euro.
The stabilisation facility was already funding the bailouts of Ireland and Portugal. It will now fund Greece’s second bailout. That leaves little – about €100 billion – to do much else, such as buying back bailed-out countries’ discounted debt. If such a sum is paltry given the scale of the problems in the bailed-out three, it is pifflingly insignificant when compared to the €2,500 billion mountain of debt owed by Italy and Spain.
And it is the absence of new weapons that could be brought to bear if the big two in the Mediterranean get into trouble that is the greatest flaw in Thursday’s package. Those countries have been contaminated with the same bug that laid low the bailed-out three. That bug has proved fatal in 100 per cent of cases to date. Perhaps Spain and Italy will prove more resilient. But if they do not, Thursday’s meeting will count for nought. And when markets are as nervous as they are now, and the underlying problems so huge, it takes little to trigger new outbreaks and flare ups. These will inevitably happen given the number of pitfalls.
A political crisis in Italy is almost certain in the months ahead. Revelations of larger losses in Spain’s banks or of previously undisclosed liabilities of regional governments cannot be ruled out. And keep an eye on Cyprus. Its banking system is bloated, heavily exposed to its Hellenic cousin and its government is now seeking EU aid, claiming that a huge explosion two weeks ago caused damage to its electricity system amounting to 15 per cent of its GDP. That could tip it over the edge.
However, even if these risks can be avoided or successfully dealt with, it is economic growth in the weak countries that is the most important underlying factor in determining whether their debt burdens are sustainable. Thursday’s package included establishing a “task force” designed to “relaunch the Greek economy”. This task force will seek to ensure the package’s growth-enhancing measures are implemented.
But the problem for Greece – as well as the other peripherals – is that even with radical reforms and the best will in the world, nobody can guarantee growth. Truth be told: economists know little about why some countries are rich and some poor. If there was a magic formula, every country would be rich.
Europeans know this only too well from experience. The former communist east Germany has received massive transfers over more than 20 years, and still lags far behind the richer part of the country. Italy’s south has had decades of transfers from the richer north, but still languishes. In both countries, disgruntlement about these transfers is considerable, even sparking a northern secessionist movement in Italy.
If Europeans’ sense of solidarity for their fellow countrymen is limited, it is even more limited for their fellow Europeans.
The Greek plan needs to work relatively quickly not only to convince the markets, but also to ensure that the peoples of the north do not definitively turn against the euro, Europe and their European neighbours.
Dan O’Brien is Economics Editor