Eurozone Needs to be Firewalled!

Following a 12 hour meeting, European finance ministers have agreed on a second bailout package for Greece worth €130bn. The deal is expected to bring the government debt in Athens down to 120.5% of gross domestic product by 2020 – this is approximately the maximum level the IMF and the Eurozone considers sustainable.

The deal came after Greece’s cabinet scraped together an additional €325 million in savings over the weekend to round off €3.3bn in cuts, which was one of the conditions set by the EU in exchange for the release of the bailout.The EU leaders have also demanded that Athens provide them with a written commitment to implementing austerity measures after a parliamentary election, which is expected to be held in April; and also to permit outsiders to supervise its finances through the presence of European Union and International Monetary Fund officials which will be permanently stationed in Greece.

 

Including Greece's first bailout worth €110bn, the new deal would mean every Greek man, woman and child will owe the Eurozone and the IMF about €22,000.

The bailout has “for the moment” saved Greece from a disastrous default. The question yet to be answered is would this deal help Greece pay off even a reduced debt burden or will the deal only delay a deeper default by a few months. A report prepared by experts from the European Union, European Central Bank and International Monetary Fund said Greece would need extra relief to cut its debts to near the official debt target given the worsening state of its economy. It also suggested that if Athens does not follow through on economic reforms and savings to make its economy competitive – its debt could hit 160% by 2020!

The majority of the funds in the programme will be used to finance the bond swap and ensure Greece's banking system remains stable; some €30 billion will go to "sweeteners" to get the private sector to sign up to the swap, €23 billion will go to recapitalise Greek banks. A further €35 billion or so will allow Greece to finance the buying back of the bonds. This would mean there will be little or nothing going directly in to the Greek economy.

Even if Greece manages to deliver everything that has been agreed, in 2020, they will be still looking at a debt level of 120% of their GDP. Importantly, they haven’t got strategies that are going to deliver growth, and with no growth there wouldn’t be income to reduce borrowings!

With this in mind, we do not believe Greece is cleared of any problem! However we do see this as a step forward for the Eurozone as a whole, as they have now managed to reduce the Greek problem to something that will not be a threat to the recovery of the European economy. The next step expected from Eurozone leaders when they meet in the G20 summit in Mexico, is to focus on building a “Financial Firewall” which will be significant enough to stop a domino effect that will disrupt the Eurozone recovery. In the summit, the EU is expected to request for increased IMF contribution by non-euro countries to help shore up a Eurozone "financial firewall" seen as vital to protecting Spain and Italy from Greek debt contagion. However, the IMF has refused to contribute further unless the Eurozone raises €750 billion, which is a move opposed by Germany.

Olli Rehn, the EU's Economic and Monetary Affairs Commissioner, is seeking to combine the existing European Financial Stability Facility (EFSF) fund worth €250bn, with a new European Stability Mechanism (ESM) worth €500bn, which will be created this summer. Germany has previously opposed calls to merge the two funds as it will increase Germany's liability and exposure to a Eurozone default by 50%, an issue that threatens a serious Bundestag backlash or revolt against Angela Merkel's effort to get agreement on more aid for Greece. Christine Lagarde, the IMF's director, mentioned that she welcomes discussion on ensuring the adequacy of the EFSF and ESM, which will help bolster the firewall against financial contagion, catalyse efforts to enhance IMF resources, and help secure global stability for the benefit of all.

 

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