Judging from their communiqué on March 15 , the eurozone finance ministers have essentially decided to sit back, cross their fingers, and expect that in the end Greece will bail itself out and that no eurozone financial assistance will ultimately be needed.
Perhaps not coincidentally, the ministers got at least half a helping hand from Standard and Poor's on March 16, when the company affirmed Greece's investment grade BBB+ rating and dropped it from the category of "creditwatch negative," stating that Greece's recent austerity measures were "appropriate to achieve its 2010 fiscal target."
At the same time, however, S&P declared that "the negative outlook reflects our view of the government's ability to sustain reform momentum over the medium term." In other words, while the Greek government may have dodged the bond market bullet in the short term and thus may be able to refinance its substantial debts in April and May unassisted in the financial markets, much more austerity will be needed to keep the bond vigilantes at bay in 2011 and 2012.
The same sigh of short-term relief, combined with nervous looks into the future, is easily visible in the eurozone finance ministers' communiqué. On the one hand, the Eurogroup opines that Greece is "appropriately implementing the Council Decision and its Stability Program aimed at reducing the government deficit by 4 percentage points of GDP to 8.7 percent of GDP in 2010...[and] that the additional fiscal measures announced by the Greek authorities on March 3, 2010, and adopted by Parliament on March 5, 2010, appear sufficient to safeguard the 2010 budgetary targets."
On the other hand, the eurozone finance ministers caution that the appropriate 2010 measures will work "provided that they are effectively, fully and time implemented." They then order the Greek government to "provide detailed information" on short-term and long-term implementation plans by May 15.
The eurozone thus expects substantial additional austerity measures to reach the budgetary targets for deficits of 5.6 percent in 2011 and 2.8 percent 2012. Not to leave any doubt about their preferred approach to austerity by Greece, the ministers state that for 2010, "significant expenditure cuts, and in particular the savings in the public wage bills, are essential for achieving permanent fiscal consolidation effects and restore competitiveness." The Eurogroup expectation is therefore clearly that Greece will follow the example of Ireland and Latvia in cutting domestic wage levels.
As for what the Eurogroup ministers are prepared to do, they simply reaffirmed their prior commitment from the European Council on February 11 "to take determined and coordinated action, if needed." Though they claimed to have "clarified the technical modalities enabling a decision on coordinated action and which could be activated swiftly in the case of need," they effectively raised the threshold for triggering financial assistance to Greece.
Separately, the finance ministers made clear that their highest priority is—no surprise—their collective economic stability. They explicitly endorsed the existence of significant interest rate spreads among their member states, declaring that the objective of any financial assistance "would not be to provide financing at average euro area interest rates, but to safeguard financial stability in the euro area as a whole." This is important for at least two reasons:
- It indicates that the days of eurozone bond rate convergence are likely gone for good and weaker eurozone members will simply have to live with substantial intra-eurozone sovereign interest rate spreads. This will have potentially large competitive implications for private industries across the eurozone, as rate differentials between member states would once again be larger than industry differentials. Greek telephone companies will from now on only be able to borrow at significantly higher rates than German telephone companies. In some respects, this is a partial return to "pre-euro normalcy," where all eurozone members did not have access to low "German interest rates." As a result, German industrial competitiveness will be further cemented by German firms' access to cheaper financing.
- The statement makes it clear that the purpose of eurozone assistance is to avoid a Greek default and the consequent harm to eurozone banks (especially in France and Germany) and the value of member states' bonds. No assistance seems likely to help Greece with a lower cost of capital, which at the last bond auction stood at 300 basis points above the rate for Germany. If this is, as Greek Finance Minister George Papaconstantinou put it, "difficult to live with,"1 then that is a problem for Greece and not the eurozone. And it would be up to Greece on its own to convince bond markets to lend to it on more lenient terms.
Also in their March 15 meeting, the finance ministers proclaimed that any financial assistance to Greece "would be fully consistent with the Treaty framework and national [e.g. German] law and would provide strong incentives to return to markets as soon as possible." Combined with statements to the press from Eurogroup president Jean-Claude Juncker, that any assistance "would not include loan guarantees,"2 this strongly suggests that any eurozone financial assistance to Greece would come in the form of a direct loan (which would legally qualify as "not a bailout") of pooled eurozone resources to Greece.3 This prospect of direct loans to Greece, in turn, has a host of implications:
No details about such a loan are available, but the tricky question will center on its interest rate and other terms. If an official loan contains "a strong incentive to return to markets as soon as possible," the implication would be that it would not be granted on concessional terms. Indeed, according to the Dutch finance minister Jan Kees de Jager, any contribution from the Netherlands would require "an effective premium on top of the costs of funding so that there will also be an incentive for Greece to refinance through the markets."4 While giving Greece guaranteed access to expensive financing, a eurozone loan to Greece might therefore not lower the country's cost of capital at all.
Secondly, it would be a mistake to underestimate the political stigma within Greece from a "direct eurozone loan" to avert default. Such a loan would relegate Greece to the status of a second class member of the EU. Obviously, the eurozone hopes that its tough terms make the Greek government even more likely to continue to implement tough measures of its own through 2011 and 2012.
Despite the likelihood of a harsh bailout, the public in the eurozone will likely see any such loan as a "tangible transfer of taxpayer euros to an undeserving recipient." In fact, a direct loan will be more distasteful domestically than the kind of below-the-radar implicit loan guarantees by eurozone state-owned financial institutions like Kreditanstalt für Wiederaufbau (KfW) or Caisse des Dépôts et Consignations (CDC), which were under discussion at an earlier point. Whose bluff will be called in this continued game of chicken? Are eurozone ministers correct that Greece has done enough already to refinance through 2010? Or was the successful previous Greek bond auction at 300 basis points over German bonds actually pricing in future direct assistance from the eurozone?
If the former, the Greek crisis is postponed again as Greece struggles to gain credibility for its austerity measures. If the latter, a potential showdown looms as Greece is only able to refinance its commitments at even higher spreads in April and May. The Greek government might refuse to sell bonds at such higher rates and instead turn to its eurozone partners for "solidarity." What if the eurozone refuses such assistance? A Greek approach to the IMF after all? A eurozone loan to Greece at rates closer to the eurozone average? The next Greek bond auction will tell us.
Finally, it is useful, in light of the recent speculation about the prospects for further EU integration, a European Monetary Fund or even an EU fiscal union, to consider whether Europe is wasting this crisis or not.
From the perspective of European federalists favoring an "ever closer Union," the answer is pretty clear. The eurozone finance ministers have effectively poured cold water on any notions of another "Great Leap Forward" for European integration. The Lisbon Treaty will not be changed, any assistance provided to a member state in the name of "European solidarity" will be subject to strict and probably IMF-plus conditionality, and any new eurozone institutional mechanisms will be kept largely secret and de minimis. Euro-nostalgics in Brussels and elsewhere longing to have the days of Delors, Kohl, and Mitterrand back will be disappointed by this meager crisis outcome.
On the other hand, today's European leaders are sensibly shying away from yet another introvert multiyear EU institution building and Treaty ratification period. For the United States and other international partners of the EU, which say they favor a Europe that can act in its own interests, an inconspicuous and minimalist EU reform agenda reflecting the tentative state of the European public acceptance of further integration, is probably the best possible outcome from this crisis. This is no time for Europe to embark on another integrationist vision.
Finally, there is the issue of how the crisis is affecting domestic policymaking in Greece (and other euro member states facing similar potential risks). Certainly, the austerity measures announced by the Papandreou government so far have been unprecedented for Greece. This suggests that maybe the crisis has ushered in a new era of responsibility among Greek politicians. The prospect of a sovereign default, in other words, has concentrated minds in Athens in a way the eurozone wants.
If Greece can maintain its new discipline, implement further austerity measures (such as scaling back its public pension system), and carry out other structural reforms, it could avoid an "Argentinean fate." Instead Greece could try to duplicate the record of Brazil.
Few experts, based on the historical record, expected Brazil in 2002–03 to avoid going the way of Argentina, yet the country still managed both an unprecedented primary surplus and pro-growth policies in the subsequent years. "Something" had changed in Brazil, and if a similar thing is true today in Greece, this crisis has not gone to waste, and the longer-term prospects for continued European integration will have improved.
In this series:
next: Greece, Act V: Talk is Cheap—and the Eurozone Likes It That Way
previous: Greece, Act III—Athens's Leverage versus Eurozone Solidarity?
Notes
1. See Greek Downgrade Threat Lowered by S&P; EU Plans Aid (Bloomberg News).
2. See Juncker Says Ministers Don't Think Aid to Greece Will Be Needed (BusinessWeek).
3. See also statements by EU officials on Bloomberg.
4. See EU Lays Groundwork for Greek Lifeline to Bolster Euro (BusinessWeek).
