The agreement reached this weekend by EMU Finance Ministers to release a new instalment of €8.7billion of the Greek financing package is undoubtedly welcome news.
It avoids (temporarily) default by the country as well as the total collapse of its economy; it also removes the risk of contagion with which it was associated. This risk was dual: on the one hand that it would extend to other countries made vulnerable by the sovereign debt crisis, in particular Ireland, Portugal and Spain; on the other that it would contaminate the entire banking sector by forcing it to recognise losses on their sovereign exposures and reduce commensurately its access to the refinancing facilities of the ECB.
Nevertheless, the agreement offers only a short respite during which long term solutions to several problems must be found at short notice:
First there is the requirement reassure the IMF that a credible rescue plan is being devised so that it can, in turn, release its own contribution (€3.3billion) to the latest planned drawdown. Abandoning the parallelism (75%/25%) between the EU and IMF loans would put the whole rescue package in jeopardy. Managing this question will be particularly delicate for Madame Lagarde, the newly appointed IMF Director who takes up her duties on July 5th.
Secondly, it is necessary to assuage Germany by ensuring that the new plan calls for both an acceleration of the privatisation process and the “voluntary” participation of a significant part of the private sector in refinancing maturing Greek debt.
What is the reaction that one can anticipate from the financial markets?
After an initial feeling of relief due to avoiding a new immediate crisis, one should expect the remaining uncertainties to – once again – come to the fore, unless the “political” process is kept very firmly under control. On the basis of the crisis management to date, it is – unfortunately - doubtful that one will avoid the public display of divergences between authorities which will fuel speculation.
In addition, I is of paramount importance that the conditionality attached to the new loans take into account the four following elements:
a) The austerity measures imposed must be judged “bearable” by the population, failing which social unrest will continue inducing a negative reaction from markets.
b) Maturities of a significant part of new loans granted by the EFSF must be extended over 20/30 years. To make this requirement compatible with the legitimate concern of lenders for security, the shares of companies to be privatised should be pledged as collateral. Once sold, the proceeds should be converted into zero coupon Bunds matching the servicing of the long term loans extended held to ensure repayment of the EFSF.
c) The interest rate on loans to Greece should be lowered so that - in combination with the extension of maturities - real relief is provided to debt servicing, improving public finances and giving a real chance to the economy to improve.
d) A robust mechanism for collecting taxes efficiently must be introduced, as called for by EU President Van Rompuy.
In addition to these measures, it will be necessary to come rapidly to grips with the question of the solvency of the banking sector and its interdependence in relation to Government financing. In this regard the results of the new stress tests constitute one of the key elements in re-establishing the necessary trust in the sector. They should not fudge the question of the “sovereign risk” exposures implied in the loans (investments) granted by the sector to EU Member States.
Given credible responses to all these questions, markets may indeed settle down and, in due course, initiate a virtuous circle sustaining a renewed cycle of economic growth.
But implementing a satisfactory solution to the EMU sovereign debt problem answers only one of many factors of uncertainty that continue to plague financial markets. Among them one should mention:
a) The troubled situation of the United States with regard to increasing the Federal debt ceiling, the twin budget and balance of payments deficits as well as the anemic economic recovery.
b) Problems related to the price levels and supply of commodities, in particular oil and food staples.
c) The instability of foreign exchange markets and the controversy surrounding the key role of the US dollar at the centre of the international monetary system.
d) The architecture and new regulatory framework of the global financial system.
In conclusion, while it is appropriate to applaud at the provisional agreement this weekend concerning Greece, given the great uncertainties remaining, it is far to early to consider the crisis as having been resolved.
Brussels, July 3rd. 2011
Paul N. Goldschmidt
Director, European Commission (ret); Member of the Thomas More Institute.
Tel: +32 (02) 6475310 +33 (04) 94732015 Mob: +32 (0497) 549259