Financial market pressure on the euro zone eased a little this week as Italy’s borrowing costs fell and bank shares stabilized. But the bloc risks fresh market attacks, perhaps as soon as in the next few weeks, as it tries to implement promised steps to address its debt crisis.
As euro zone officials struggle to finalize details of an agreement struck by their leaders at a July 21 summit — a deal which was intended to draw a line under the crisis — many investors are already demanding more radical solutions.
In what has become a pattern in the 18-month-old crisis, leaders’ decisions have taken so long to implement that by the time they come into force, they appear too little, too late to convince the markets. The July 21 deal promised to make the euro zone bailout fund, the European Financial Stability Facility, more flexible by allowing it to buy bonds in the secondary market and lend to troubled states pre-emptively, among other measures. It also contained a plan for private holders of Greek bonds to contribute to rescuing the country, by taking part in a voluntary debt swap that would save a projected 37 billion euros.
But it could be several weeks before the changes to the EFSF are approved by national parliaments in the euro zone — Germany’s Bundestag will only consider it in late September — and there are signs that Greece is having trouble persuading enough investors to sign up to the debt swap. Meanwhile, a dispute over collateral for governments making emergency loans to Greece threatens to delay or conceivably even shatter the entire deal.
“Between now and the end of the first quarter of 2012, it is highly likely that the euro area as a whole is going to have one, if not more, existential crises and market pressures bring it to the brink,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London. “There is an extreme amount of noise out there and it is possible that these pressures could mount as early as September. What if the July 21 decisions don’t get ratified by the national parliaments?”
COLLATERAL:
The Eurogroup working group, which draws together euro zone finance ministers, the heads of euro zone treasury departments and representatives of the European Central Bank, was due to hold a teleconference on Friday to discuss the collateral issue.
The dispute focuses on whether only Finland will receive collateral — Austria, the Netherlands, Slovakia and others are now also keen to have similar protection — and how much will be granted in what form. The European Commission has warned too many calls for collateral would make the deal unworkable.
Failure to compromise could mean Finland dropping out of a second bailout package for Greece. This would not necessarily doom the bailout — the countries demanding collateral account for only a small fraction of the bailout funds to be provided — but it would undermine cohesion in the euro zone and could therefore alarm markets. Meanwhile, Greece warned on Friday it might not go ahead with the debt swap unless 90 per cent of the private sector took part; it said on Thursday the take-up so far was only around 50 per cent. Without a substantial contribution from banks and insurers, it would be harder for rich euro zone governments to justify aiding Greece to their taxpayers. A third area of concern is how much the International Monetary Fund will contribute to the second bailout of Greece, which envisages 109 billion euros of fresh official funding.
The IMF agreed last year to contribute about a third of the first bailout, which totaled 110 billion euros, but it is unclear if the Fund’s emerging economy stakeholders are willing to continue shoveling large amounts of aid into a region which does not seem able to cope effectively with the crisis.
When the first Greek bailout was announced in May last year, the IMF quickly pledged its support. This time, it has not said specifically how much aid it will provide; Brazilian and Indian directors of the IMF have warned the Fund’s management against pouring excessive sums of money into Europe.
Such concerns were evident this week in trading of Greek bonds. Although many financial market levels in the euro zone stabilized or improved, Greece’s two-year government bond yield, which reflects fears that the country may suffer a full-scale default in the next two years, soared to 46.6 per cent from 37.7 per cent a week earlier.
“HORRENDOUS ALTERNATIVES”:
Ultimately, the euro zone may well muddle through in implementing its latest crisis package, as it has with past packages. Finnish officials on Friday held out the possibility of compromising on the collateral issue, saying they were open to adjusting their deal with Athens; some commercial bankers say privately that Greece should be able to get about 80 per cent participation in its debt swap, enough for it to move forward.
So the euro zone may succeed in having all major elements of the package, including a reformed EFSF, in place by the end of October. Until then, it will count on the European Central Bank to buy Italian and Spanish bonds if necessary to stave off disaster in the markets. Full implementation of the package may not be enough, however, to deter fresh market attacks on indebted countries.
Investors know the EFSF’s power is finite; given its other commitments, its effective capacity of 440 billion euros would not be enough, for example, to finance a multi-year support scheme for Italy if that became necessary.
Belgian Finance Minister Didier Reynders has called for a bigger EFSF, and some European officials say privately that the fund may need to be doubled or tripled. But that is a politically difficult step which Germany are France are not now prepared to take, and if Paris agreed to shoulder a bigger fiscal burden with a big increase in its guarantees to the EFSF, that could fuel market concern about France’s own debt position.
