Financial markets greeted with relief the plan agreed by European Union leaders on Thursday to contain the bloc’s sovereign debt crisis. But although the leaders for the first time tried to address Greece’s solvency problem by acknowledging a technical default and reducing the country’s debt, many economists doubt the package is sufficient to resolve the crisis.
“The deal is substantial, but it may not be the end of the debt crisis,” said Christian Schutz, senior economist of Berenberg Bank in London. “They have bought a few more months of time to try and address the weaknesses the crisis is exposing.”
Richard Barwell, U.K. economist at RBS Global Banking & Markets in London, agreed that the deal wouldn’t solve the long-term debt problems but stressed the political significance of the agreement. “The leaders reaffirmed the commitment of the big countries at the core of the Eurozone to the troubled countries in the periphery,” he said.
Under the package agreed at the summit meeting in Brussels, the EU and the International Monetary Fund will extend €109 billion in fresh financing to Greece under a new three-year arrangement. Crucially, the new loans will carry a reduced interest rate of 3.5 percent, compared with 5.2 percent on the country’s existing bailout loans, and maturities will be extended to between 15 and 30 years with a 10-year grace period, up from 7.5 years currently. Ireland and Portugal will enjoy the same interest-rate and maturity concessions on their EU/IMF loans.
“The decision to cap at 3.5 percent the interest rate which Greece, Ireland and Portugal have to pay for official support from other Eurozone countries and the IMF will help,” said Barwell.
The new Greek bailout also includes, for the first time with a Eurozone country, proposals for private sector involvement that include an effective writedown of existing debt. Banks and insurance companies can choose from a menu of options to exchange existing debt for obligations with longer maturities and reduced interest rates. Those concessions are expected to contribute another €37 billion to the rescue package, although bankers and economists say the leaders’ statement lacked sufficient detail to predict how private creditors will react.
Fitch Ratings became the first rating agency to make public its views on the new bailout package, saying that it would reduce the rating on Greece to “restricted default” should plans go ahead to make bondholders assume part of the cost through debt rollovers or swaps.
“The EU has somehow to deal with the very delicate balancing act of the private sector making a contribution to the Greek bail out whilst not causing contagion to Ireland, Portugal, Spain and Italy,” said Gary Jenkins, head of fixed income at Evolution Securities, a London investment bank. “The positive movements in bond yields for these countries suggested they succeeded on day one,” he said, but added, “there must be doubts whether they will be successful over the longer term.”
German Chancellor Angela Merkel had demanded private-sector involvement in any Greek debt reduction as a price for fresh German support. The European Central Bank had strongly resisted anything tantamount to a default because that would affect its own substantial holdings of Greek bonds. But EU leaders managed to overcome that objection by including in the package a €35 billion guarantee to cover the Greek bonds that the ECB holds as collateral for loans to Greek banks. Jürgen Stark, a member of the ECB’s executive board, said the guarantee would protect the ECB even if credit rating agencies declared a selective default by Greece.
Some senior officials acknowledged that the agreement was only a step in the right direction. “It does not mean that all the problems in the Eurozone have been solved,” Ewald Nowotny, governor of the Austrian central bank, said in an interview with Austrian radio.
Privately a senior official close to the negotiations concurred. He feared that there was a “black hole” at the center of the plan: the absence of any increase in the lending capacity of the European Financial Stability Facility, the euro zone’s bailout fund. “It needs more money and it needs to show that it has it,” he said. This official also questioned whether the package would require the private sector to make a big enough contribution to easing Greece’s debt burden. “There is not enough of a ‘haircut’ on Greek debt,” he said. A reduction of only around 20 to 30 percent in Greece’s debt burden – which currently stands at around 150 percent of GDP – will not make a dramatic difference to the country’s growth prospects, he suggested.
The new agreement aims to prevent contagion by enabling the EFSF (and its successor from mid-2013, the European Stability Mechanism) to intervene in the secondary bond markets of any euro area country if the ECB judges that “exceptional financial market circumstances" pose a threat to financial stability.
Had the intervention mechanism existed in recent weeks, it could have been used to counter the sharp rise in Spanish and Italian bond yields. “The possibility that the EFSF can proactively intervene to support euro member states facing difficulties before they are shut out of the markets is a big positive,” said RBS’s Barwell.
Although financial markets responded positively to the summit, with yields on Greek bonds dropping significantly, there are anxieties about how long this mood will survive as investors dig into the complex details behind the broad outlines announced by EU leaders.
Economists such as Berenberg’s Schutz point out that the broader economic outlook is not helping resolve Europe’s debt crisis either. Signs of slowing growth are evident in the U.S. and the U.K. in particular.
Bill Gross, co-chief investment manager at Pimco, the world’s largest bond investor, warned this week that, because of high government debt ratios, the developed economies are facing an extended period of sub-normal growth of only around 2 percent rather than the 3 percent that they have enjoyed historically.