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Rescue or Risk for Greece?

Author: Christopher Alessi
February 23, 2012

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Following an EU decision to provide Greece with a new $172 billion bailout package (WSJ), the debt-laden country now must wrestle with implementing steep austerity measures amid a worsening recession. The eurozone agreement, expected to reduce Greece's debt burden from 160 percent to 120.5 percent of GDP by 2020, includes a 53 percent debt write-down by Greece's private bondholders. The European Central Bank also agreed to indirectly help Greece by distributing future profits on its holdings of Greek bonds bought on the secondary market.

With much of the public deeply opposed to the bailout agreement, Greek leaders will have to demonstrate the political will to implement the EU-IMF-mandated austerity measures--including public spending and pension cuts and a 22 percent reduction in the private sector minimum wage. If affected, those cutbacks could exacerbate Greece's economic downturn, complicating its ability to chart an efficient growth course.

What's at Stake

Many Greeks are concerned they have ceded too much sovereignty (NYT) to foreign lenders like the European Central Bank and IMF for a bailout that may just postpone an inevitable default. Indeed, on Wednesday credit rating agency Fitch downgraded Greek debt to C from triple-C, saying it would further downgrade it to a "restricted default" (Reuters) following the private sector bond exchange or restructuring. In the event of a subsequent disorderly default, eurozone sovereigns, Europe's highly exposed financial sector, and global markets would all be put at risk.

The Debate

Some analysts and economists warn that the new package will prove self-defeating for Greece, while others think it is a step in the right direction toward alleviating Greece's debt burden.

While the new bailout deal "prevents an immediate crisis" in Greece, it does not go far enough, argues TIME's Michael Schuman. Moreover, Schuman says, the strict austerity measures compound Greece's inability to dig itself out from under its pile of debt.

Germany's Handelsblatt notes that the new aid package is "based on more realistic assumptions than the first, increasing the chances that the targets will be reached." But it also cautions that the private sector haircut may not be big enough, and that Germany and other European countries may ultimately need to write off a portion of their Greek claims.

Policy Options

Bruegel director Jean Pisani-Ferry defends austerity in Greece as necessary, but says the EU should also focus on social justice in Greece by encouraging more equitable burden sharing. "It cannot call for a cut in the minimum wage and at the same time assign secondary importance to the fact that tax evasion among the top ten per cent of the taxpayers costs one quarter of income tax receipts," he writes.

Meanwhile, many G20 finance ministers and central bankers (DerSpiegel), who are meeting in Mexico City this weekend, have called on the EU to expand the $665 billion European Stability Mechanism that is set to come into effect in July. "The eurozone must increase the resources of its firewall so the markets can be reassured that it can respond to any eventuality," George Osborne and Jun Azumi, the British and Japanese finance ministers, write in the Financial Times. However, Germany, the de-facto leader of the eurozone, vehemently opposes such a move.

Background Materials:

The eurozone, once seen as a crowning achievement in the decades-long path of European integration, is buffeted by a sovereign debt crisis of nations whose membership in the currency union has been poorly policed, explains this CFR Backgrounder.

The European Union needs an effective growth plan in the beleaguered eurozone to confront the "meager and deteriorating" prospects for many countries in the zone, writes Bruegel's Benedicta Marzinotto.

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