Six problems facing the eurozone
From riots in the street to rejected haircuts: six problems facing the eurozone
1 The Greek bailout may not be big enough This latest rescue of Greece, consisting of a 50% writedown on the bonds held by private investors, plus €100bn of new loans, is meant to make its public finances sustainable by 2020. But the deal is only aimed at bringing Athens‘ debt pile down to 120% of GDP, close to where Italy is today, and that’s a level that many investors would still deem far too high. In the meantime, the «troika» of the IMF, EC and ECB are going to be on the ground in Athens, combing through every tax and spending decision, and making sure the government sticks to its harsh austerity plans. The end result may be a sickly economy, still mired in debt in nine years’ time.
2 The private sector «haircut» could be rejected Negotiations with the banks about the precise terms of the 50% write-down on Greek bonds are continuing. Eurozone governments have already agreed to stump up €30bn (£26.5bn) in so-called «credit enhancements» to make the deal more acceptable to investors; but hedge funds, insurers and pension funds all own Greek bonds, and their agreement will be needed if the deal is to be «voluntary», as Brussels hopes. This is important because if the debt restructuring is deemed compulsory, it will trigger billions of euros of credit default swaps. There are already anecdotes circulating about hard-nosed hedgies hoping to hold out. The 21% debt writedown that was proposed as part of the last eurozone rescue deal, in July, was still stuck in fraught negotiations with Greece’s creditors when it was superseded by this latest deal.
3 Political and social unrest Both Greece and Italy have had to make big promises to their eurozone partners about how they will cut back public spending, raise taxes and reform their economies. With a recession looming across the eurozone, many ordinary voters in these countries may feel that is too big a price to pay. There are already riots on the streets of Athens; there could be more social and political unrest to follow in the months and years to come, particularly if economic recovery is a long time coming. One close observer of the situation remarked that Greece will effectively become an «economic protectorate», ruled by remote control from Brussels – that could eventually wear thin with members of the public. Italians, too, may not take kindly to having to swallow a nasty dose of austerity at the behest of Berlin.
4 The boost to the EFSF could fail Germany and France have agreed to «leverage» the bailout fund, the European financial stability facility, by using it to insure the first 20% of losses on new bonds issued by Italy and Spain. But analysts say investors could just split the 20% insured chunk and the 80% uninsured rump and trade them separately. So the measure would bring down the yield – the interest rate – on the insured fifth, but leave Italy and Spain paying the current eye-watering interest rate on the rest. The other wheeze hatched in Brussels to make the facility’s resources go further was a special purpose vehicle to hold some of its debts, which it is hoping will secure investments from China, and possibly other G20 countries such as Japan and Brazil. Nicolas Sarkozy secured a promise of co-operation from Beijing; but promises of solidarity are one thing, and cold, hard cash is another.
5 The banks could starve the economy of credit Europe’s banks have been told to take a more realistic view of the billions of euros worth of sovereign bonds they hold on their books, and make sure they’re holding enough capital to protect themselves against the risk of default by Greece, Portugal, Spain and Italy. They could do that by raising investment in the financial markets – from cash-rich states such as China, for example – or they could choose instead to repair their balance sheets by reducing their liabilities. That would mean calling in loans and depressing new lending to families and businesses throughout Europe – exactly the credit crunch eurozone politicians are so keen to avoid. Any such lending squeeze would be likely to exacerbate the slowdown that is looming: many economists already expected the European economy to slide into recession in the fourth quarter of the year.
6 The ECB could refuse to play its part With the EFSF’s insurance scheme likely to take time to get off the ground, the European Central Bank will have to continue to play a major role in buying up the bonds of Italy, Spain and other troubled countries if the markets are to be stabilised. The ECB’s new boss, Mario Draghi, left, has suggested the Frankfurt-based bank stands ready to help; but it is under pressure from Berlin to stick firmly to its remit. Most economists believe Draghi will also have to swiftly reverse the two interest rate rises imposed by his predecessor, Jean-Claude Trichet, earlier this year, if the eurozone is to avoid a deep downturn.