A Crisis That Could Go All The Way

by Shane Fitzgerald

In the wake of yet another cautious statement from Angela Merkel on the proposed Greek rescue package, the authors of the Eurointelligence daily news bulletin worry that “this crisis could go all the way.”

The Greek government has outlined a series of spending cuts and tax increases it plans on implementing this year as part of the package but the German Chancellor wants to see a list of austerity measures to be taken in 2011 and 2012 before providing support. Faced as she is with strong domestic opposition to any bail-out, it is assumed that Merkel is trying to delay action until after the North-Rhine Westphalian elections on 9 May. If so, she is playing a dangerous game. Greece has €8.5bn of bonds coming due ten days after the election, leaving a very tight window in which its problems can be addressed.

European leaders are piling pressure on Germany to confirm that it will provide its share of aid under the plan (a hefty €8.5 billion), while Dominique Strauss-Kahn, IMF Managing Director, and Jean-Claude Trichet, European Central Bank President, are to address the Bundestag this week in an attempt to win over reluctant German parliamentarians who must approve any deal.

Market reaction to the latest prevarication from Berlin has been stern. The yield on Greek two-year bonds yesterday rose three percent to 13.5%, the highest in the world, as investors acted on concerns that the €45 billion Eurozone/IMF rescue package could yet fall apart, leaving Greece in default.

Other peripheral Eurozone bond markets such as Portugal and Ireland are already suffering contagion effects from this latest dip in confidence. Portuguese two-year bond yields rose more than three-quarters of a point to nearly four per cent yesterday while Ireland’s jumped by a similar amount to three per cent.

Ms Merkel and her finance minister, Wolfgang Schäuble, are keen to stress to German MPs and voters that they are acting to ensure the stability of the euro rather than simply to rescue a profligate member state. But so far, European leadership seems to be hindering rather than helping the Greeks get to grip with their crisis. Alan Beattie points out that the European Council started talking about a Greek rescue in mid-February yet a deal has still not been signed off on. Since then, he notes, Eurozone authorities have managed the difficult trick of incurring the cost of the IMF’s presence while squandering much of the benefit:

Since the fund is providing some of the loans, Greece will be branded with the IMF stigma, for sure. But, apparently for reasons of self-esteem, the eurozone wants to do most of the lending itself – at higher interest rates than the IMF – and to set the conditionality. At a stroke this dilutes the benefits of the fund’s cheaper lending, forsakes some of its policy credibility and diminishes its use as a political flak jacket [for deflecting domestic anger].

Looking beyond what Wolfgang Munchau is calling “the most important week in the 11-year history of Europe’s monetary union”, sorting out Greece is a necessary condition of Euro stability, but it is certainly not a sufficient one. The European Economics and Monetary Affairs Commissioner, Olli Rehn, recently insisted that Eurozone nations urgently need to coordinate economic policy so as to tighten fiscal discipline, redress macroeconomic imbalances and improve crisis management. This is a tall order. While Article 136 of the Lisbon Treaty authorises states “to strengthen the co-ordination and surveillance of their budgetary discipline”, the radical steps that now seem necessary to restore stability to the Eurozone could yet necessitate a treaty change for which there is scant appetite.

This broader set of Eurozone problems will not go away but they represent a longer-term policy concern. Europe needs to take decisive action on Greece now.