Friday, 22 July 2011

A New EU Package - Buying Time!

Well, rather to my surprise - and relief - European leaders managed yesterday in Brussels to cobble together a new financial deal that provides further support to the ailing Greek economy. The new package comprises Euros 109 billion of official financing, with private sector involvement expected to add a further Euros 39 billion (this part is dependent on bondholder agreement, not yet assured). The interest rates payable on much of Greece's debt are being reduced and maturities extended, all of which takes a bit of pressure off the Greek 'sovereign'. This is a big step forward and the result will help to bring down total Greek debt and provide the country with a breathing space to put through various reforms.

However, the new deal leaves some important issues and questions for later consideration. These include the following:
  • Will the deal restore Greece to solvency? Probably not, so there will be further rounds of discussion further down the line. Rating agencies might already treat the present deal as a 'selective default', but it's probably not the end of the story.
  • Some funds are expected to be raised through a wide-ranging privatisation of Greek assets, with figures as high as Euros 50 billion being mentioned. But it would be unwise to put much weight on this as privatisation takes time and should not be rushed for the sake of quick sales (probably at fire-sale prices).
  • The current deal does nothing to stimulate Greek economic growth, though in due course that remains the key to improving Greece's situation.
  • Greece remains in the Eurozone,which constrains the policy actions it can take to improve its competitiveness. It remains to be seen whether this will be viable for long. On the other hand, exit would clearly be messy and difficult. It is not an easy option.
For the Eurozone more widely, the leaders agreed to make the use of the EFSF (European Financial Stability Facility), a fund of Euros 450 billion, rather more flexible, but there has not (yet) been an agreement to increase the size of the fund - some economists argue that it needs to be of the order of Euros 2 trillion to be really credible, and I agree.

Moreover, a declaration by the Eurozone leaders, released at the time of the summit, has some worrying features, in particular:

'All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest.'

The history of member states adhering to fiscal targets is not a happy one, and there are no penalties for failure to comply. More importantly, in a European economy still struggling to recover from recession, it's not obvious that these fiscal targets are very sensible ones, especially in a context where the European Central Bank has already started to push up interest rates. Sure, deficits and debts need to be managed, but it's surely not urgent to achieve stringent targets quite so rapidly.

So, some welcome progress in Europe, which buys some time. But still no sign of an agreement on the debt limit in the US, so that remains a worry.

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