Cause and Effect in European Politics and Law

"The Grand Bargaining" is over, it is time for action

Ralitsa Kovacheva, April 6, 2011

The International Monetary Fund has changed the course and is now pressing Greece to restructure its debt because the Fund is doubting that the current austerity measures are sufficient, German magazine Der Spiegel reported citing its own sources. The Greek debt amounts to about 150% of GDP and many analysts have long warned that its restructuring is the only salvation for the country. According to the magazine, the options are to apply the so-called haircut, to extend maturity or to reduce interest rates on Greek loans, but in all cases the creditors will suffer losses.

The IMF officially denies that it is leading such a policy towards Greece. But there are signs that even the EU isn’t far from this idea, although it has not commented on it bluntly. But the aim is the Union to be ready with the framework for bank restructuring first, to allow for an "orderly resolution" of failing banks. There was also a proposal the temporary rescue fund for the euro area (EFSF) to have the power to buy debt of peripheral economies on the secondary market, but it was not accepted. Recently, the eurozone leaders have decided to lower the interest rate on the Greek loan from the EU and the IMF by 1 percent, but that is now considered insufficient. Given the intention of the ECB to raise the interest rates in the coming days, the payment of the interest on Greek loans will become extremely difficult. The same applies to other troubled economies in the periphery of the eurozone.

Currently, Portugal is being targeted by the financial markets, after the yield on its 10-year bonds raised to nearly 10 percent. The Financial Times commented that this level was higher than that of the Irish bonds at the time when Dublin requested a rescue loan from the EU and the IMF. The interest rates on the Portuguese loans also went up reaching nearly 6%. The expectations are the country's debt, which currently amounts to 82.8 percent of GDP to reach 100 percent in the years to come.

Meanwhile, despite the austerity measures, the country failed to meet its budget deficit target and the government revised it up to 8.6%. However, the outgoing Portuguese Prime Minister Jose Socrates keeps claiming that the country can avoid the bailout. Obviously, however, investors do not believe him. As if to add more fuel to the flames, the Moody 's credit rating agency has downgraded the long-term government bonds to Baa1, only a month after it had downgraded it by two notches to A3.

To the economic crisis in the country a political crisis was added too, after the Parliament rejected the fourth in a year package of measures, proposed by the Government of Jose Socrates, to reduce the deficit. As a result, the Socialist government resigned. Now only few still believe that Portugal can withstand without an external assistance until the early elections on 5 June. Although it is a small economy, Portugal can cause big problems to the eurozone mostly because of the big exposures of Spanish banks to the country, but also of banks in other countries in the eurozone core. So probably the rumours are true that Lisbon is under pressure from its partners in the euro area not to delay further and to ask assistance from the rescue fund.

Meanwhile, fears are growing about Ireland after the national stress tests showed that local banks needed further 24 billion euro. Thus the total price for saving the country’s banking sector will reach 70 billion. The rescue loan from the IMF and the EU amounts to 85 billion euros. According to the Finance Ministry in Dublin, the Irish debt will reach 111 percent in 2013. Against this background, the new government is trying to negotiate a reduction of the interest rate of the bailout loan, but so far it has been meeting resistance from some eurozone countries, notably France and Germany, who insist Dublin to consider an increase of its corporation tax. Prime Minister Enda Kenny has repeatedly said he was not prepared even to discuss the matter after the previous government had specifically noted in the 4-year budgetary strategy, that the corporate tax of 12.5% would not be increased under any circumstances.

The market pressure on the three countries is increasing also as a result of the lack of a decision to increase the effective capacity of the temporary rescue fund (EFSF) at the last European Council. At the same time, many consider the permanent fund - the European Stability Mechanism (ESM) not sufficient to guarantee the stability of the euro area. Some of the main criticism is that the ESM is held hostage of national interests of individual member states because it is based on an intergovernmental approach. It was no accident why media called it “The Grand Bargaining”.

The ESM will not be allowed to buy debt of eurozone countries on the secondary markets which, according to some influential analysts, was a way to reduce the market price of the financing for troubled economies. As a condition for its help, the ESM provides, if necessary, the country concerned to reach an agreement in advance with its creditors to restructure debt, so that they could bear their share of the losses. The fund will have a preferential creditor status, which means that its loans will be paid with priority.

In this situation it seems that, despite all the efforts in the past year, the European Union continues to act under pressure of events rather than be proactive. Now all the questions related to the worst scenarios for Greece, Ireland and Portugal start not with “whether” but with “when”. So the faster the necessary decisions are taken, the more serious consequences can be avoided.