Greece's second rescue is probably not the last

Greece, after much bickering, will receive a second bailout after finance ministers from the European Union agreed on Tuesday to a rescue package that includes 130 billion euros (A$160 billion) in aid and a deal whereby private Greek bond investors accept a 53.5% write down on their holdings. The agreement negotiated between Greece’s government and the “Troika” of the European Central Bank, IMF and the EU means Greece can meet a bond repayment of 14.5 billion euros due in March. But the sign-off from EU finance minsters failed to ignite global stocks or the euro on concerns that Greece’s problems are already insurmountable and that an uncontrolled default looms for the indebted country. The bailout carries austerity measures that will add to political and social tension in Greece and further undermine Greece’s economy, which slumped 7% last year. These austerity measures, which include 3.6 billion in additional spending cuts and tax rises in 2012, another 15,000 public sector job cuts in 2012 and a 22% reduction in the minimum wage, lay behind the protests in Athens earlier this month when Greece’s parliament approved the deal. Austerity measures have proved counterproductive all over Europe in arresting government deficits because slower or negative economic growth reduces tax revenues and boost welfare payments. Further contractions in output will only make it harder for Greece to reduce its ratio of government debt to GDP to 120% by 2020 as the bailout terms demand from about 160% now. Austerity measures tied to the first bailout in 2010 helped crush Greece’s economy and drive up the ratio of government debt to GDP from 110% then. The time may well come when Greek authorities decide that defaulting and exiting the euro is a less painful alternative and one that offers a better chance of restoring the country’s long-term economic health. Authorities are concerned that an uncontrolled default by Greece could raise the prospect that investors lose faith in debt-ridden Portugal, Spain and Italy and strain the European banking system. Global investors appear to have gained faith in recent months that the ECB and other European authorities can contain the crisis to Greece. This confidence is based on the small size of Greece (about 2% of eurozone GDP) and the actions taken by the authorities to ensure that a Greek default does not have cascading negative effects akin to the Lehman Brothers collapse of September 2008. The single most critical action has been the ECB’s announcement in December to offer European banks unlimited three-year money (subject to collateral) via repurchase agreements. Bank demand for this facility has been unexpectedly strong and this appears to have substantially reduced the risk of a bank liquidity crisis.

Quagmire

Tristan Cooper, Senior Sovereign Analyst at Fidelity, says it’s difficult to feel optimistic about the Greek bailout deal as a Greek exit from the euro area seems a likely outcome as there is scant evidence that the country will be able to escape its economic quagmire. “The conundrum is how can a country that is three years into a devastating and ever-worsening recession turn itself around and start to grow,” Tristan says. “Without growth, debt sustainability is a mirage. Greece desperately needs to revive its economic competitiveness yet the required internal devaluation is politically and socially unacceptable." This point is not lost on European policy makers, particularly in those countries that are paying for the rescue, Tristan says. “They despair over the Greek situation but are pushed into further assistance by their fear of the unknown – the contagion effects of pushing Greece out of the euro.” Attention will now focus on Portugal and Ireland to see if they can twist out more concessions from their programs, Tristan says. “In our view, this is likely given the Greek lesson that rapid fiscal contraction does not work,” he says. “The Troika is under immense pressure to show that its economic prescriptions can succeed in Ireland and Portugal, when they have manifestly failed in Greece.” What can be said in favour of the second rescue package is that it buys more time for European authorities to build better defences to protect the rest of Europe in case of a Greek default. Source: Fidelity and Bloomberg We would like your opinion.  Do you think that Greece will default?