Euro Zone Acts to Dodge Greece's Bullet --- But More to Come From PIIGS?     Print

More Rounds Are Liable To Come from PIIGS

Greece seems set to tough out the financial tempest unleashed on the country by its huge fiscal over-runs and sovereign debt. That prospect could help relieve pressures on other troubled economies in euro zone, at least temporarily.

The break-through for Greece came this week when EU President, Herman Van Rompuy announced that "Euro area member states will take determined and co-ordinated action if needed to safeguard stability in the euro area as a whole.” In other words, the euro zone has not cracked in its worst-ever crisis – at least, not for now.

Although no details were given, Van Rompuy said that the Greek government has not requested any financial support. But most analysts believe that the EU governments are signaling their readiness to proceed at least to credit guarantees and probably eventually to a package of bridging loans for Athens.

It was an unprecedented step for EU governments, notably Germany, to promise in effect to bail out one of the 16 member-states in the euro zone. This commitment is intended to stave off a process of “falling dominos” as other countries’ finances start toppling in the wake of a Greek default on its international borrowing. A collapse in Greece would worsen the outlook for the entire euro zone by making world markets even more reluctant to lend money to its weakest members: Portugal, Ireland, Italy, Greece and Spain (a country whose plight was recently described by Paul Krugman) -- unaffectionately dubbed PIIGS by bankers who worry about them or hope to make a financial killing on them.

For the moment, international investors should be readier to buy bonds from these countries now that the EU has rallied behind Greece. The agreement followed talks involving German Chancellor Angela Merkel and French President Nicolas Sarkozy – the two biggest players in the euro zone. They were joined in a closed-door meeting ahead of the announcement by key EU officials including Jean-Claude Trichet, head of the European Central Bank, the key institution in the euro zone.

The move signals, among other things, that other EU leaders are ready to believe that Athens will live up to its pledges of severe austerity action: this means pay freezes in the bloated public sector; an end to “cooked books” that distort the real accounts in official Greek financial reporting; and tougher tax enforcement.

This draconian reform package has been publicly accepted in no uncertain teams (“we will spill blood”) by Greek Prime Minister George Papandreou. Now it will be up to his Socialist government to impose these draconian measures on the country’s militant trade unions, quelling protestors in the process.

Merkel, herself a conservative, is under pressure from her center-right coalition partner at home not to expose German taxpayers to the cost of a bail out, and she has publicly warned Athens that the deal comes with strings attached: "Greece won't be left alone but there are rules and these rules must be adhered to. On this basis we will agree on a statement."

She added that France and Germany believed there should be a "new architecture for markets," suggesting that Paris and Berlin will use the crisis to pursue their agenda of reform of the world's financial markets in the wake of the recession.

That could be a silver lining. But any substantive moves toward improved EU economic governance will have to wait, probably for months, while world markets make up their minds about whether or not Greece will ultimately default on its bonds and about whether or not the euro zone can weather the storm. Greece is only one of the PIIGS whose weak economies sport ratios of debt to gross domestic product that are three times higher than the EU ceiling of three percent. Greece’s is 12 percent, and speculation against Greece’s future has worsened the outlook for these other countries.

On the brighter side, any growth in confidence about the determination and follow-through of the government in Athens would help relieve pressure on the euro by making international lenders readier to buy bonds from all the PIIGS. Even so, the promise about Greece is a stopgap measure that can hold only until bigger euro zone economies manage to find their feet. But, for the moment, the long-term issues about the euro zone have to take a back seat to the immediate urgency about Greece.

The crucial statement of support for Athens, made at an EU summit meeting, called on the Greek government to implement ambitious stability measures with enough rigor to “effectively reduce the budgetary deficit by four percent in 2010.” That goal, even if achieved, would leave Athens with a debt-to-GDP radio of roughly eight percent. But the turnaround could almost certainly convince world markets that Greece and the euro zone had surmounted the challenge.

A different view of German and French motives comes from Simon Johnson, a noted economist in the United States: he says that these governments want a weakened euro in order to make their exports more competitive against American goods. Maintaining uncertainty about Greece and the other PIIGS serves that end.

EU unanimity is vital for Greece’s chances of staving off a feeding frenzy by speculators as Athens tries to turn around its economy. But analysts say that supportive talk (and even credit guarantees) will probably not be enough to salvage Greece’s finances and that ultimately the country is likely to need a package of loans put together by other EU governments and the International Monetary Fund (IMF). After the EU summit announcement, Austrian Chancellor Werner Faymann predicted that IMF funds would make up a significant part of any bailout, along with loans from EU members.

"We are not talking about a donation or subsidies, we are talking about loans with interest, which we provide to help a country in order to avoid irritations on financial markets and crises nobody can handle anymore," he said on Austrian radio.

The vision of a sounder economic system emerging from the crisis is well laid out in an article in The Washington Monthly about how even the most dysfunctional governments can be forced to change by market and political pressure.The magazine is not alone in believing that Papandreou plans to do it – and can. In "Angst on the Aegean," an article by Economist editor Bruce Clark, Papandreou aides are quoted explaining that he wants to use the crisis as leverage to reform Greece's whole political economy--to attack, in particular, the endemic government corruption at the heart of the country's fiscal woes.

So his efforts are worth watching, and not only because they may help determine the future of the euro zone, one of the great political and economic experiments of modern times. They are also a test of whether it is possible for a country mired in debilitating corruption (and there are many that are more corrupt and worrisome to their partners in the euro zone and across the Atlantic with the United States) to change its spots – and its financial outlook.