Evaluating the July 21 Eurogroup Meeting
What’s at stake: European leaders reached an accord Thursday to reduce Greece’s debt burden and prevent a collapse of confidence that has threatened to engulf some of the region’s largest economies. The total package agreed to on Thursday includes some startling breakthroughs in Europe's approach to solving the destabilizing euro debt crisis. Although it is more than many hoped for or expected to get, market participants have remained confused about certain elements of the deal.
General impression: better than expected, but short of a once-and-for-all resolution
Gavyn Davies writes that the European summit on Thursday has resulted in a belated, but still impressive, step towards a resolution of the sovereign debt crisis. The measures were clearly more significant than the markets expected, but at the same time they have fallen short of a once-and-for-all resolution of Europe’s debt problem.
Joseph Stiglitz writes in the A-List that Europe may have taken an historic step in its meeting on Thursday – it seems, for once, to have done more than “just kick the can down the road”. Mohamed El-Erian argues that history will only label this a success if Thursday’s courageous compromises are followed by proper enhancements and skillful execution. There is still much to do if this historic summit is to mark the beginning of the end of Europe’s painful debt crisis.
Wolfgang Münchau argues that the effectiveness of an agreement should not be gauged by the immediate market reaction, let alone by how the agreement compares with expectations. Thursday’s agreement succeeded in staving off an imminent collapse of the eurozone. That is undoubtedly its greatest achievement. But we should not fool ourselves. It will only succeed if it is followed by other agreements that fix its gaps.
On the EFSF and its ability to limit contagion
Jacques Cailloux argues that the statement clearly gives the impression that euro areapolicy makers are increasingly ‘getting the message’, with 3 new tools being created: a precautionary programme, a lending facility for non programme countries to recapitalise banks and a bond buying programme in the secondary market. However, the level of detail provided is low, making it hard at this stage to really tell how the new tools will work in practice and how efficient they will end up being. In particular, there is insufficient information available to tell how preventive those tools will end up being deployed and this is related to the lack of clarity surrounding the so called “appropriate conditionality” that will be imposed on member countries accessing these new help mechanisms.
Jacques Cailloux also argues that a key limitation of the announcement is that it did not address the size of the EFSF. A prerequisite to increase the flexibility of the EFSF was to increase very significantly its size with a view of ultimately having a lending capacity of around Eur2trn. Indeed, under the amended EFSF which will aim at having a lending capacity of Eur440bn, and given current and likely commitments, the EFSF will be left with a little more than Eur300bn of lending and or buying capacity – a too small amount to restore investor’s confidence that the euro area has once and for all dealt with its sovereign crisis. In his view, the crisis will linger with markets likely to test the EFSF firepower.
On the 2011-2014 financing gap for Greece
Peter Spiegel writes that the financing gap for Greece between now and 2014 is €172bn as estimated in a recent report by the European Commission. Out of this €172bn, there’s €57bn left in the old Greek bailout and €34bn of those normal loans in the new one, for a total of €91bn. Greece’s privatisation programme is supposed to raise €28bn in the next three years. And the remaining €54bn comes from the so-called “private sector involvement” – the complicated menu of rollovers and swaps being offered to private bondholders. Spiegel notes that because of the uncertainty around the effectiveness of the bond buyback plan, it was not counted as part of the financing programme.
On the extent of PSI
Miranda Xafa and Domingo Cavallo write in VoxEU that the deal implies a 21% reduction in the net present value of debt owed to bondholders, which constitutes about 70% of Greece’s total public debt. This implies a reduction of 15% in total public debt, which would bring it down from 156% to 132% of GDP. With most analysts estimating the needed debt reduction closer to 50%, this deal is unlikely to ensure debt sustainability even if Greece fully implements the medium-term fiscal plan it has just voted into law.
Rajiv Sethi writes that what makes the mechanism strategically interesting is that the payoffs from participation are highly sensitive to the overall participation rate. The higher the participation rate, the greater will be the ability of Greece to meet its financial obligations not only on the new issues but also on the outstanding ones. Participation by some raises the value of the assets held by the remainder. If the target participation rate of 90% is met, then those who decline to participate will find themselves holding bonds that are much less likely to default than is currently the case. In anticipation of this effect, yields on Greek bonds (and the cost of insuring them with credit derivatives) fell sharply following the announcement.
Rajiv Sethi also notes that participation is voluntary, so current bondholders can simply choose to do nothing. For this reason, the financing offer does not trigger payouts on credit default swaps. The fact that credit default swaps are not triggered by the offer, coupled with the lowered likelihood of default on current bonds, benefits sellers of protection on Greek debt. So who loses as a result of the financing offer? First and foremost, those who bought naked credit default swaps, thus making a directional bet on a credit event that is now less likely to occur. It is quite conceivable that the plan was designed to have precisely this effect.
On the Marshall Plan
Tony Barber notes that midway through Thursday’s save-the-euro summit in Brussels, European officials distributed a draft communiqué that spoke of a “European Marshall Plan” for Greece. When the summit ended, this grandiloquent phrase had been quietly dropped from the final text. The statement, nonetheless, included a paragraph on a comprehensive strategy for growth and investment in Greece that will make use of structural funds andmobilise other EU funds and institutions such as the EIB.
Sony Kapoor writes that it is good that they at least mentioned the need for growth and investment. The absence of any reference to relaxing co-investment requirements for structural funds that is a big obstacle to their utilization at this point is very disappointing. This is no Marshall Plan, just empty words for now, although the mention of the EIB is encouraging even though it is likely to provide mostly loans.
Benedicta Marzinotto of Bruegel was an early advocate of such growth enhancing measures. In a policy brief, she noted that significant volumes of Structural and Cohesion Funds have been pre-allocated but remain undisbursed or uncommitted. In Portugal, unused funds amount to 9.3 percent of GDP, in Greece close to 7 percent, and in central and eastern European countries about 15 percent. These funds should be part of a temporary European Fund for Economic Revival (EFER) for 2011-13, which would promote economic growth in crisis-hit countries and facilitate structural reforms. For countries under financial assistance in particular, the European Commission has a role to play in identifying the ‘right’ objectives for which the funds should be used. She also argued that greater efforts should be made to exploit synergies between EU grants and EIB loans, allowing EIB loans to finance the total costs of a project or programme in small countries, and leveraging the whole EU budget to attract private investment.
Barry Eichengreen wrote before the summit that history suggests that a Marshall Plan for Greece might actually work. The Marshall Plan, by financing strategic investments, helped the recipients to ramp up their exports. Aid-financed reconstruction turned Rotterdam into a commercial hub for Northern Europe. US aid underwrote the imports of coal and investments in hydroelectric power needed to get industry running again. And, in some cases, like France, US funds were used to extinguish part of the public debt. Importantly, these projects were neither dictated by the donor nor chosen by the recipient, but decided in collaboration. The recipient, moreover, had to put up matching (“counterpart”) funds for each and every project.
Ryan Avent writes that talk of a new Marshall Plan is all well and good, but a meaningful effort to support the Greek economy (to say nothing of the Irish, Portuguese, Spanish, and Italian economies) will take a meaningful fiscal committment from core economies, and that's not a prospect German voters are likely to look kindly upon. Without that, however, the periphery faces years of grinding contraction and painful reductions in real wages.
Fiscal contraction at the core
Paul Krugman points that the statement has also its let’s do-1937 paragraph: “Public deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest.” OK, so we’re going to demand harsh austerity in the debt-crisis countries; and meanwhile, we’re also going to have austerity in the non-debt-crisis countries. Plus, the ECB is raising rates. The Serious People are determined to destroy all the advanced economies in the name of prudence.
Edward Hugh writes that last week’s flash PMI readings seem to have attracted rather less attention than they might. Nonetheless, the fact of the matter is that it is steadily becoming clearer that the current slowdown in Eurozone economic growth is turning into something more than just another one of those pesky “soft patches”. The pace of economic expansion in core Europe has slowed dramatically, falling back in July for the third consecutive month, according to the latest flash PMI.
The risks going forward
Lex writes that the political fight over the nature and extent of integration is now where the euro’s long-term risk lies. Jacques Delors used to make a virtue of the EU’s ability to lurch towards more integration after a crisis. But the nature of the sovereign debt crisis is such that without more integration, the euro will fall apart; its internal contradictions are so glaring.
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