Greece: Hardly an Epilogue!

March 26, 2010 4:45 PM

So, the Greek rescue deal is here.

One-third IMF money, two-thirds from all eurozone countries, according to their European Central Bank (ECB) capital share, which translates into Germany with just over a quarter and France 20 percent of the eurozone contribution. There are no hard figures in the eurozone statements, but subsequent press announcements suggest a total of about €20 billion to €22 billion, or substantially enough (about 50 percent of the total estimated need) guaranteed financing to assist Greece in refinancing its needs during April and May. This is more European money than could have been expected and clearly gives Europe the lead in terms of quantity of financing.

So far so good, and this is a good deal in the sense that it is not a one-off Greece-only initiative, but an arrangement that can be used in the future. Not a new European-only institution, but nonetheless a construction to deal with Greece-like scenarios in the future.

As always, however, the devil is in the details. Here the eurozone agreement leaves several open ends.

First is the issue of what will actually trigger any aid to Greece now that the distribution has been sorted out. Initially, Greece would have to request this direct bilateral aid from its partners with all the political stigma attached to it.

Then the IMF and eurozone would seemingly disburse aid to Greece simultaneously, although it is far from obvious that the IMF, the huge eurozone representation on its board notwithstanding, would simply rubber stamp decisions made in Brussels to disburse money . Can the IMF really hand that kind of authority to anyone else? How the deal is aligned with IMF statutes is far from obvious and precise timing matters. There is obviously a lot of political prestige in "leading any rescue operation," or providing the first funding. Will the eurozone be content to simply provide money after the IMF? Or will Chancellor Angela Merkel be willing to provide German funds ahead of the IMF?

Second is the issue of the conditionality of any eurozone aid. The Lisbon Treaty's "no bailout" clause still stands (it has, in fact, proven remarkably resilient during this crisis, again illustrating the prominence of EU law over politics). That provision means that any assistance "has to be considered ultima ratio [last resort—love Latin in official documents], meaning in particular that market financing is insufficient. Any disbursement on the bilateral loans would be decided by the euro area member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank. The objective of this mechanism will not be to provide financing at average euro area interest rates, but to set incentives to return to market financing as soon as possible by risk adequate pricing. Interest rates will be nonconcessional, i.e., not contain any subsidy element." (Emphasis added.)

What does "insufficient market access" mean—400 basis points or 500 basis points above German bonds? There is no threshold bond yield defined here. If in reality extreme interest rates would be acceptable and a failed bond auction would be required to establish "lack of financial market access," the trigger mechanism for eurozone aid would be an actual Greek default. That would be the most dangerous game of chicken so far in this crisis.

Certainly, this agreement could still easily end up simply providingmore pressure on Greece to "do a Latvia" and bail itself out through domestic cuts in living standards.

Furthermore, the requirement for eurozone unanimity in triggering any disbursement introduces national vetos to any Greek assistance. This opens up the trigger process for any kind of domestic politicking. Would Angela Merkel, for instance, be willing to accept any German aid ahead of the May 9 regional elections in Nordrhein-Westphalia? Or to avoid a politically damaging legal challenge at the German Constitutional Court?

It certainly is not without irony that this deal of supposed "European solidarity" ultimately had to be based on national vetos and bilateralism. This is clearly more akin to the Chiang Mai Initiative in East Asia than EU qualified majority voting.

And how can something be labeled "financial assistance" if it cannot contain any "subsidy element"? The envisioned bilateral eurozone loans will seemingly be provided on market terms and without any concessional terms to lower Greece's cost of capital.

Obviously, eurozone leaders believe that their firm commitment to—in extremis—finance about half of Greece's needs this year and thereby remove essentially all of the near-term outright default risk on Greek debt will in itself be sufficient to lower Greece's cost of capital. This may be true, but quite possibly something markets will want to test to find out the "threshold yield" for eurozone aid. Financial market probing—certain to be labeled "speculative attacks" by EU politicians—seems inevitable.

There could, of course, be some financial relief for Greece from the one-third of the money from the IMF, which could be at significantly below-market rates. Ironically, the fact that IMF money would thus likely be available to Greece at lower interest rates than eurozone loans underlines the fact that "regional European conditionality" in this crisis has proven to be IMF-plus rather than more lenient for Greece.

That is an outcome that should lower concerns about the effectiveness of regional "monetary funds" also in Asia, for example. At the end of the day, even in the most integrated part of the world—the European Union—neighboring partner governments proved unwilling to write the check because of domestic political pressure. Democratic governments everywhere will therefore likely face similar prohibitive obstacles in providing concessional financing to "Greece-like countries" from regional monetary funds. Even authoritarian China would likely struggle to bail out a neighbor deemed to be "undeserving." The global rules-based approach of the IMF has certainly been vindicated.

The ECB also did its part by taking the nuclear option off the table—i.e., denying collateral status for Greek debt at the end of 2010. This removes the influence of discredited credit agencies over the Greek future and paves the way for a more "flexible response" system of collateral requirements by the ECB, such as a risk-weighted system in which risky Greek debt would carry a higher penalty than German bonds. This ECB gesture would reduce liquidity risk, helping to lower Greece's cost of capital during 2010 more effectively than what the eurozone decided today. Certainly, it brings the ECB closer to a traditional role as the de facto lender of last resort for a crisis country.1

Eurozone leaders are paying lip service to "strong coordination of economic policies in Europe." However, as they frame this intention as part of "the European growth strategy," it can safely be dismissed as without substance and a sop to integrationists.

Were European leaders to be serious about promoting growth in Europe in a coordinated manner, they would implement and expand on the Services Sector Directive, which would raise growth in a sector accounting for two-thirds of the EU economy. In fact, the best way to promote domestic demand in surplus countries like Germany would be to free up its services sector in a coordinated manner with the rest of Europe through such an approach.

Again, here it is ironic that France—which recently brought up the issue of "German domestic demand" in the eurozone—was the biggest obstacle to an ambitious EU Services Sector Directive.2

Last, the eurozone leaders have charged the new Belgian president of the EU Council with the task of presenting a new robust framework before the end of the year, aimed at strengthening the "surveillance of economic and budgetary risks and the instruments for their prevention, including the Excessive Deficit Procedure…. [and a]…crisis resolution respecting the principle of member states' own budgetary responsibility." In other words, trying to find a way of getting member states to adhere finally to the Stability and Growth Pact (SGP).

All options are to be on the table. But since renegotiating the Lisbon Treaty on this basis will never be politically feasible, this means that Germany's proposal to facilitate eurozone expulsion is dead, just as serious sanctions will never be applied on countries with an excess deficit. Thus the SGP will remain largely as it is today. However, as the Greek crisis has proven, its function will from now on be monitored and enforced by financial markets, with the result that political enforcement mechanisms remain impotent and irrelevant. It's trying to get back to "1992 basics" for the European Union, but that will be the extent of the European fiscal union coming out of this crisis.

A final irony: The very financial markets that EU leaders love to vilify ultimately will be called upon to enforce what EU leaders cannot get themselves to do. And in the end, as European solidarity has been found to be nonexistent during this crisis, financial markets will prove to be the real pillar of enforcing EU policies (i.e., the SGP) and achieving European integration under this generation of European political leaders.


1. I am indebted to my colleague Angel Ubide for this astute observation.

2. I am indebted to my colleague Carlo Bastasin for pointing out this irony in France's position.

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Jacob Funk Kirkegaard Senior Research Staff

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