Will they or won’t they provide assistance to Greece' That question is being asked by EU watchers and financial market participants alike in the days before this week’s European Union Council summit on March 25 and 26. The machinations read like an old time thriller with tensions growing within the eurozone as member states opt for one (or more) of the potpourri of plans on the table.
Last year, the Greek government admitted that their budget deficit was 12.7 percent of gross domestic product or about four times the 3 percent EU limit. This has spooked global markets in recent months as members of the EU deliberate whether they will help. And it has battered the euro because of fears that Athens might default and this in turn could lead to default in other indebted eurozone economies such as Spain and Portugal. And the hard line taken by Germany along with indecision of other eurozone member states has exacerbated the uncertainty surrounding Greece’s fiscal status. And as everyone knows — markets hate uncertainty.
As the Greek story continues to unfold, the roots of the problem lie at the inception of the European Monetary Union and the Stability and Growth Pact. In pre-EMU days, countries with problems as dire as Greece’s were able to deflate their currency as one of the ways to fend off fiscal woes. That option is no longer available to Greece since it gave up the drachma in favor of the euro in 2001.
The Greek government has already said it would turn to the IMF as a last resort, but both the European Central Bank and the European Commission have resisted any such move. Speaking in Brussels on March 18 Greek, Prime Minister George Papandreou told European lawmakers that there needed to be a European solution to his country’s debt problems and that he would prefer this to IMF intervention, even though he said that Greece did not need any money. A decision to turn to the IMF would amount to a defeat for the German finance ministry and the Bundesbank, where officials have been fiercely opposed to such intervention within the eurozone for any purpose other than technical advice.
Last week, the Greek prime minister requested that European Union leaders at their summit this week agree to a package of standby loans to restore confidence in the country's debt. And a senior Greek official said that the country may seek IMF aid over the April 2 to 4 Easter weekend because Athens holds out little hope for aid from the EU. The Greek prime minister is in steady contact with IMF Managing Director Dominique Strauss-Kahn — the IMF has been giving Greece technical assistance on the debt crisis and has said it stands ready to help. Although the EU has made general pledges of support, Germany, the EU's biggest economy, is notably reluctant to give any aid. Athens argues that it needs help such as loans, guarantees or bond purchases to lower what is says are crippling borrowing costs. Despite Greece's series of painful budget cutting tax hikes and spending cuts that have caused mass protests, investors demand a yield of some 3 percentage points more for Greek 10-year bonds than for German bunds.
But Greece is not alone. On March 17 the European Commission warned the eurozone’s four largest countries — Germany, France, Italy and Spain — that their economic growth forecasts for the next three years were too optimistic, putting at risk their ability to cut their budget deficits in accordance with the European Union’s fiscal rules. The Commission asked these four countries along with others including Austria, Belgium, Ireland and the Netherlands to spell out exactly how they intended to meet their medium term deficit reduction targets. No other eurozone countries are regarded as in such dire circumstances as Greece, but most are struggling with booming budget deficits and public debts that, in the Commission’s view, have wiped out the benefits of roughly 20 years of EU fiscal prudence.
The European Union approved the Stability and Growth Pact (SGP) in 1997 as part of the Maastricht Treaty process that established the European Monetary Union and the European Central Bank. The Pact's purpose was to support the fledgling euro and to keep fiscal miscreants (read Italy at that time) in line. The accord was drawn up at the insistence of Germany (and the Bundesbank, the model for the European Central Bank) in order to whip into line those countries thought to be fiscally irresponsible. The Pact's tight fiscal rules helped underpin the creation of the euro. Governments were told to balance their budgets in the medium term and were forbidden to run a deficit of more than 3 percent of gross domestic product. Greece joined the EMU on January 1, 2001.
The SGP establishes a limit of 3 percent of gross domestic product for budget deficits, defines the exceptional conditions under which breaching the limit can be accepted and establishes how and when fines can be levied against countries with excessive deficits. However in early 2005, the EU Council under pressure from France and Germany relaxed the rules, responding to respond to criticisms of insufficient flexibility and to make the Pact more enforceable. The ceilings of 3 percent for budget deficits and 60 percent for public debt were maintained, but the decision to declare a country in excessive deficit now relies on certain parameters. They are — the behavior of the cyclically adjusted budget, the level of debt, the duration of the slow growth period and the possibility that the deficit is related to productivity enhancing procedures.
It should be noted that the Pact was created when European economies were basking in 2-plus percent annual GDP growth and unemployment was declining amid the global economic boom of the late 90s. The slowdown in the early 2000s exposed the fault lines between Germany, France and Italy on one side, and smaller countries on the other side that stuck to the Pact. The rules were bent to allow Germany, Portugal, France and Italy more time to balance their budgets. But the problem going forward was how to make the Pact more flexible yet at the same time without creating a window for irresponsible government spending.
A two class eurozone has been a reality since 2005, when EU budget discipline rules were suspended and then rewritten to avoid sanctions against France and Germany after they repeatedly breached the deficit limit. The Greek crisis has strengthened that trend, whether or not Athens ends up being bailed out by its partners. For example, although Greece has been placed under EU fiscal tutelage, no such intrusion has been imposed on France — its deficit is more than twice the 3 percent ceiling of GDP. Any financial backing for Greece is expected to be an ad hoc arrangement, with Germany calling the shots as Europe’s de facto lender of last resort. This two class eurozone is bound to cause resentment and aggravate mistrust between big and small states, north and south.
There is no doubt that the Greek debt crisis will change the way the eurozone works, but probably not in the direction that the single currency’s founding fathers had hoped. When they negotiated the Maastricht Treaty in the early 1990s, Helmut Kohl, François Mitterrand and Jacques Delors believed that the EMU would lead to a closer political union with more federal governance. But flaws uncovered by Greece’s fiscal mess at this writing seem more likely to entrench a two-class system in which the major countries exert ever more control over those who have gone astray such as Greece.
German chancellor Angela Merkel’s advisers have argued that any form of bailout from within the eurozone would face a challenge at the German constitutional court in Karlsruhe. The court gave a green light in 1998 for German participation in the single currency, but only on the basis of strict observance of stability rules, with debt and deficit limits for participating countries and no bail-outs allowed. And the German decision is critical because Berlin would inevitably be the largest contributor. Finance officials have been working for weeks on technical alternatives, such as a coordinated series of bilateral deals that might not flout a bailout ban. But the chancellor’s advisers have consistently warned that the legal problems might prove insuperable.
Throughout the debate over ways of helping Greece, the German chancellor has insisted that her fundamental position is how to preserve the stability of the euro. She has also been adamant that it was up to the Greek government to put its own house in order with a drastic austerity program before any help could be considered. However, support for IMF intervention has been growing with Italy, the Netherlands and Finland all arguing in favor.
However, resistance has come from monetary officials including at the ECB on the grounds that IMF conditionality would not merely bind Greece, because monetary policy is decided for all 16 members of the zone. And ECB officials have been critical of the German position warning that the cost of inaction could be far worse than offering temporary financial support. There has also been strong political resistance, particularly in Germany and France, to the idea that the U.S. and other IMF members would in effect be called on to rescue a member of the eurozone, thus exposing the inability of the Europeans to resolve a financial crisis in their own back yard.
In a Financial Times poll released on Monday, the strength of German resistance to bailing out Greece was underscored — respondents were overwhelmingly opposed to offering financial support to Greece as it struggles to control its public sector deficit. They were also strikingly more hostile than other Europeans. Almost a third of Germans believed that Greece should be asked to leave the eurozone. But at the same time, about 40 percent also thought Germany would be better off outside the single currency — a significantly higher level of skepticism than in France, Spain or Italy.
The Stability and Growth Pact was supposed to work by deterrence alone. The possibility of punishment was supposed to be so terrible that the threat alone would be enough to ensure compliance. It failed early on when France brushed aside threats and EU finance ministers proved merciful when meting out punishment to Germany and Italy. But the Pact was viewed as a tool to make eurozone fiscal policy sustainable. By forcing governments to keep their budget deficits below 3 percent of GDP, the Pact would limit the ratio of public debt to GDP to less than 60 percent. Given the extraordinary conditions of the last couple of years, naturally this deterrent has not worked.
On Monday, Greece was offered a significant concession by the ECB, which indicated for the first time that it might continue providing liquidity against Greek bonds even if the country was downgraded further by ratings agencies. ECB President Jean Claude Trichet said his “working assumption” was that Greece would not face problems. But he added that if that assumption was “too optimistic … then we would look at the situation.” Exclusion from the system, which has acted as a life support for the eurozone banking system, could prove catastrophic for Greece. Previously the ECB has stuck strictly to the line that there would be no exceptions.
Mr Trichet also strongly rejected the idea proposed by Germany’s chancellor that countries unwilling to reform could be expelled from the eurozone. “The euro area is not à la carte. We enter the euro area to share a common destiny,” he said. Exiting the eurozone was legally “impossible,” he added. Mr Trichet said Greece could be helped if necessary via a set of emergency loans from other eurozone countries on the condition that there were no subsidies involved and on the basis that there was a threat to the entire EMU.
Although Germany has appeared increasingly isolated in holding out against any formal rescue package, at the same time, there seems no prospect of any deal without Berlin’s agreement. But some say it might still be possible to agree to a first step of a deal this week — that is setting out the conditions under which an emergency rescue would be launched but without any direct connection to the Greek crisis, and only if it does not imply that any rescue would be automatic according to the German view.
On Wednesday, France and Spain called for a summit meeting of all EMU members on Thursday, immediately before a full 27-state European Union summit in Brussels. But there was resistance in Brussels and Berlin to holding a meeting unless a successful outcome was in sight. However, the German government said that no such deal would be agreed this week, saying Greece would have to show it was unable to raise money in international capital markets before it would be justified.
Germany is also calling for “a substantial contribution” from the International Monetary Fund towards any Greek rescue and demanding that negotiations begin on tough new rules to enforce future budget discipline in the eurozone, even if that means renegotiation of the Lisbon treaty. French officials are still hopeful an outline deal to help Greece can be hammered out by EU leaders or at least by eurozone leaders on Thursday. But German Chancellor Angela Merkel is determined that financial assistance will be a last resort. José Manuel Barroso, president of the European Commission, has called for agreement on an emergency mechanism under which help could be given to Greece, including bilateral loans from eurozone members.
To be continued….
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