Europe is still struggling to avoid the threat of default as investors warn Greece will soon risk violating the terms of its second bailout in three years.
Seven months of negotiations ended in the pre-dawn hours in Brussels with Greece winning 130 billion euros ($172 billion) in aid it needs to avoid a March bankruptcy. Any respite may prove temporary after it signed up to a program of austerity and economic reform aimed at slashing debt to 120.5 percent of gross domestic product by 2020 from about 160 percent last year.
Even with investors and central bankers chipping in to relieve the debt burden, economists from Citigroup Inc. to Commerzbank AG concluded Greece may again fail to deliver amid a fifth year of recession, looming elections and social unrest. The upshot could be the removal of aid and renewed debate over the merits of fresh assistance before year-end as policy makers shift toward doing more to inoculate the rest of Europe.
“The bailout bandage is on, but it won’t take much to unravel,” said David Miller, partner at Cheviot Asset Management in London. “The euro zone has done its best to ensure that Greece will deliver on promises, but there is considerable scope for backtracking on deficit reduction.”
Financial markets signaled doubt the accord will fix Greece’s travails permanently or spell an end to the two-year debt crisis. The euro surrendered initial gains against the dollar and European stocks fell from a six-month high.
By supporting Greece, Europe’s high command chose the financial and political cost of awarding fresh money over the risk of a bankruptcy that could splinter the 13-year-old euro area. At least 386 billion euros has now been committed to save Greece, Ireland and Portugal with investors predicting the government in Lisbon at least will need more support.
To tackle future fiscal emergencies and limit contagion, officials held out the prospect of boosting their firewall to 750 billion euros from a planned limit of 500 billion euros when a permanent aid fund is paired with the temporary facility starting in July. They also cajoled investors into providing more debt relief in an exchange meant to tide Greece past a March bond repayment.
In return for the new cash, Greece signed up to cuts in pensions, the minimum wage, health-care and defense spending, as well as layoffs of state employees and asset sales. It must implement that austerity with unemployment already topping 20 percent, meaning more retrenchment might end up only compounding the debt stress.
“The danger of Greece saving itself into economic depression and having to default and exit the common currency zone remains substantial,” said Christian Schulz, an economist at Berenberg Bank in London. Jennifer McKeown of Capital Economics Ltd. repeated her forecast that Greece will quit the euro by the end of the year.
The odds that Greece will remain encumbered by debt were exposed by an analysis by European Union and International Monetary Fund experts that highlights what could go wrong with a country unable to grow out of its fiscal travails by devaluing its currency. In a worst-case scenario, the debt may rebound to 160 percent of GDP by 2020 rather than nearing the 120 percent the IMF deems “sustainable.”
“Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it,” said the report by the so-called troika, which also includes the European Central Bank.
‘Fully Fledged’ Default
The study exposes the difficulties Greece faces in delivering its promises amid a crisis-torn economy, said Guillaume Menuet, an economist at Citigroup in London. The country may miss its deficit goals as soon as June and have to prepare for a “fully fledged, coordinated default” by year-end, he said.
Joerg Kraemer, chief economist at Commerzbank in Frankfurt, calculates the debt ratio will rise to 127 percent if annual growth is 0.5 percentage points lower than assumed.
“Greece will find it difficult to shoulder even the reduced debt in the long run if it does not implement far-reaching reforms,” said Kraemer. “For the second half of the year, there is a significant probability that a frustrated EU stops payments to Greece.”
If 2010’s 110 billion-euro bailout is anything to go by, Greece will struggle to reach its targets. Privatizations supposed to reach 19 billion euros by 2015 have so far yielded about a tenth of that amount and Barclays Capital estimates that, even with promised fiscal cuts, just 16,000 state jobs were shed in the three years through the third quarter of 2011 compared with 466,000 in the private sector.
In a bid to prevent renewed failure even if it means eroding Greek sovereignty, European governments will tighten their scrutiny. A special account will be established that gives priority to keeping Greece solvent before releasing money for the country’s budget. A European Commission task force will also be embedded in Athens.
The biggest near-term risk may be elections which could be held as soon as April. In a poll released today, nearly every Greek questioned by GPO for Mega TV said the budget measures promised by the current government were too harsh.
“The new Greek government could refuse to follow through on its commitment,” said David Mackie, chief European economist at JPMorgan Chase & Co., who noted Europe’s leverage over Greece will recede once investors complete a debt exchange and the first aid payments are received.
Other hurdles remain. Unless 90 percent of investors sign up to the bond swap, Greece may need to enforce it, creating legal difficulties. Finland and Germany are among the nations whose lawmakers must back the new loans as voters attack the bailouts. German Finance Minister Wolfgang Schaeuble said the IMF plans to add 13 billion euros to the bailout, less than the third it contributed to the first program.
The euro area has nevertheless “bought time” for countries such as Portugal to prove they are more creditworthy than Greece and to erect stronger defenses in the form of a larger bailout fund, said Carsten Brzeski, an economist at ING Groep in Brussels.
“The often-cited Greek can has again been kicked down the road,” he said. “The good thing is that the can is still on the road, but it requires a huge amount of stamina and patience to keep it there.”