Tags: Greek | Bailout | Risk | Crisis

Greek Bailout Reduces Risk But Unlikely to End Crisis

Tuesday, 04 May 2010 01:27 PM

 

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A 110 billion euro ($143.17 billion) plan to bail out Greece reduces the risk of a debt default this year but is unlikely to end the crisis of confidence shaking weak economies on Europe's periphery.

Euro zone governments and the International Monetary Fund now appear set to overcome remaining political obstacles and extend emergency loans to Greece in time for it to redeem 8.5 billion euros of maturing bonds on May 19.

But it will not be clear for many months, possibly years, whether the government of Prime Minister George Papandreou, facing strikes by angry unions, can push through and maintain the austerity steps it has promised in exchange for the bailout.

It is also unclear if the uncompetitive Greek economy, mired in a recession that is expected to last into 2011, can survive the austerity and remain in the euro zone, where it is unable to devalue its currency or control its own interest rates.

If the Greek recovery plan falters, other highly indebted euro zone states such as Portugal, Spain and Ireland could risk losing their access to the financial markets, presenting the euro zone with a bigger challenge.

"There have been several examples of countries successfully enacting fiscal adjustments of this size, so economically it can be done," said Alberto Alesina, a professor at Harvard University.

"But in most of these cases the economy reacted well and grew during the adjustment process. The Greek economy is very weak so this is a big question mark."

Several analysts said Greece's new targets for cutting its debt appeared more realistic than a plan agreed earlier this year with the European Union.

The new plan includes tougher government spending cuts but because of the weakness of the economy, it gives Greece two more years, until 2014, to bring its budget deficit under the EU's ceiling of 3 percent of gross domestic product.

"It is clearly a tough program, impressive in every respect," said Erik Nielsen of Goldman Sachs.

But sustaining the austerity measures, which include salary and pension reductions for the public sector, tax hikes and a rise in the retirement age, may hinge on the support of a public which is already outraged at corrupt politicians whom they hold responsible for the crisis.

Although parliamentary committees are investigating several scandals, no politician has yet been brought to justice.

"Society's tolerance depends on whether by end-June they see some results, the picture is better and the deficit is reduced," said Costas Panagopoulos, head of ALCO pollsters in Athens.

"But to limit the social explosion the government must satisfy the feeling of social justice, people should not feel they are the only ones who pay."

Opinion polls show people increasingly oppose austerity and disapprove of the government's handling of the crisis, although support for Papandreou personally is high.

If the austerity program is sustained, it will deal a heavy blow to Greek companies, including banks. Greek bank shares have tumbled 26 percent this year, although they have not quite reached lows hit during the global financial crisis early last year.

Greece's international backers are clearly concerned about the impact on banks; EU and IMF officials said the Greek government would provide liquidity to the banking sector and also create a fund to guarantee banks' solvency.

To help return the economy to growth, Papandreou has announced his intention to push reforms of Greece's labor markets, civil service and regulation. If successful, a crackdown on tax evasion could by itself improve Greece's budget balance by several percentage points, some economists estimate.

But these reforms could take years to be implemented and bear fruit. They will face challenges including an obstructive civil service and the old guard in Papandreou's Socialist party.

Another source of risk is political tensions within and among rich euro zone countries over how to handle debt crises in the zone. German public opinion in particular has been strongly against helping Greece.

Three months ago, a strong, explicit pledge of financial support for Greece might have calmed investors enough for Athens to retain its ability to raise funds from the markets, making such a huge bailout unnecessary.

Instead, governments bickered over terms of the bailout and the conditions required of Athens. They eventually reached an agreement in order to protect their single currency, but with less than three weeks to go before Greece's debt refinancing.

This suggests that if Greece continues to struggle and requires even more aid, it may not be forthcoming.

And economists estimate that if Portugal, Ireland and Spain eventually come to require similar three-year bailouts, the total cost could be some 500 billion euros. Politically, this would be very difficult for the euro zone.

The European Commission is to propose a permanent mechanism for handling such crises on May 12, possibly drawing on a German proposal for a European Monetary Fund. But actually creating the mechanism may require contentious changes to the European Union Treaty that would require many months.

© 2014 Thomson/Reuters. All rights reserved.

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