In May 2010, the EU could praise itself for its ability to put together a 110 bn € rescue package for Greece in cooperation with the IMF and, only weeks later, for agreeing on a 750 bn € rescue fund for other potentially illiquid Eurozone members. At the time, these steps appeared as an important demonstration of European solidarity, as a signal of the Eurozone’s ability to get its act together although it had no tested crisis management instruments at its disposal, and as a manifestation of strength in the face of financial markets ready to speculate on the bankruptcy of Eurozone member states or even a breaking apart of the currency union.
A year later devastating pictures from all over Europe hit the covers of the newspapers and magazines: people flock to the streets in Greece to demonstrate against austerity measures and structural reforms which they blame on the European Union. Protesters are also out in Lisbon, Portugal, just like in Spain which so far has not requested financial assistance from the EU and the IMF, but which implements a long list of reforms and budgetary cuts in order not to lose further credibility in the financial markets. In France, the Eurozone’s second largest member state after Germany, a right-wing extremist, Marine Le Pen, wants the country to leave the Euro – and roughly a fifth of French voters would chose her if Presidential elections were held tomorrow. In Germany, skepticism towards the single currency and in particular towards the Southern European members of the Eurozone, has grown tremendously since the package for Greece was launched in spring last year.
In June 2011 – just as in spring 2010 – the European Monetary Union finds itself at a crossroads. The choice is once again to provide Greece with credit and guarantees, or to let the country slip into bankruptcy within weeks. This would indeed occur if the so-called Troika, which consists of the European Commission, the European Central Bank und the IMF, refuses to hand out the next 12 bn € tranche of the loan package agreed last year since Greece’s restructuring and consolidation programme is not going far enough.
This scenario cannot be ruled out. The acting Managing Director of the IMF, John Lipsky, is apparently taking a tougher stance on EMU issues than his predecessor, Dominique Strauss-Kahn. Last Monday, Lipsky took the Eurozone Finance Ministers by surprise when he announced at their crisis meeting that the IMF would only pay out its 3.3 bn € share in the next tranche of the rescue package if the Eurozone countries would actually agree on the terms of a new bail-out for the time after March 2012, which is when Greece is actually expected to return to the financial markets.
Within a year, more evidence has emerged that Greece may actually be insolvent – not just illiquid. If this is really so, more credit is wasted money as further public debt piles up and is unlikely to be paid back entirely. As early as spring 2010 there were serious doubts that Greece could be illiquid. But at that point in time, financial support for Greece was still reasonable, as it bought time for the EU governments to prepare for the complex scenario of a sovereign debt restructuring.
This was expensive time, and it was wasted. Indeed, the EU has achieved many things in the last few months, including progress with the reform of economic governance mechanisms. Also, the European Financial Supervision Authorities have taken up their work. But the EU missed at least two opportunities: firstly, it did not draft a credible growth programme for Greece which would actually help the country to grow out of the debt trap. Secondly, it did not prepare the Eurozone in such a way that a state insolvency and a debt restructuring would actually be a credible and feasible scenario.
In order to achieve this, the EU would have to find ways to limit the damage of public debt restructuring on the banking sector. This could be achieved by a recapitalization of weakened banks, by creating a European Banking Fund or by limiting participation of banks in the capital of other banks. Each of these solutions has its downsides – but the costs of the current wait-and-see attitude are even higher. Today, in the Eurozone’s current state, debt restructuring with an orderly default procedure is no realistic scenario for Greece. The reactions of the European Central Bank, which has spoken out against debt restructuring in an unusually blunt manner, and the critical stance of the IMF give an idea of the perceived risks related to this scenario.
This would leave the Eurozone with two options: Firstly, a disorderly default, which is possible if Greece does not fulfill the political conditionality. The donors will probably insist more and more on their conditions, in particular as it will get more and more difficult to get parliamentary approval of further rescue packages. A default would destabilize the banking sector and would require the governments to put more public money into stabilization efforts. Contagion effects on other member states would also have to be dealt with. In the latter case, the EU could be faced with an option which it to date denies: the Euro’s survival could be at risk, which could force the member states to adopt far-reaching steps of integration such as the introduction of Eurobonds.
The second option would be the next episode of a story we know too well for now: more credit and guarantees in exchange for further conditions – a pathway which should escalate the frustration in both the donor and the recipient countries. The political polarization within the Eurozone has today already reached a tremendous degree, and further shock waves that may run through the European Monetary Union will make it more and more probable that donor countries, just like Slovakia did in 2010, actually withdraw from the joint rescue packages.
Today it seems that the EU embarks on the second option. If it does, it is all the more urgent that the time it gains is politically used to make debt restructuring a viable alternative in order to solve Greece’s debt problem. More fundamentally, it is an essential component of the functioning of the European Monetary Union in the long run. The market as a disciplining mechanism should back the set of rules and sanctions that are currently being hardened in order to control irresponsible fiscal behaviour and economic imbalances in the future.