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Waiting on the Eurozone

Author: Christopher Alessi
October 4, 2011

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Eurozone finance ministers meeting in Luxembourg postponed until November (NYT) a decision on whether to release the next tranche of last year's €110 billion EU-IMF financial rescue package for Greece, even as global markets tumbled. The decision followed a weekend announcement by Greece that it will record a deficit of around 8.5 percent (Guardian) of GDP for this year, significantly above the mandated 7.6 percent target.

Greece has insisted that it will run out of funds by mid-October if it does not receive the €8 billion installment. But European finance ministers indicated on Tuesday that they would move to extract all agreed-upon budgetary measures (DeutscheWelle) from the indebted state, while waiting for a report on its finances by representatives of the European Commission, the European Central Bank, and the IMF, known commonly as the troika.

After three days of talks with the troika, the Greek government agreed on a 2012 draft budget on October 2 that includes a €5 billion package of tax increases and spending cuts (FT). At the same time, Greek Finance Minister Evangelos Venizelos said thirty thousand public-sector workers (NYT) will be cut by the end of 2011.

Analysts think that the troika will ultimately keep Greece from a disorderly default by providing the country with a second €109 billion EU-IMF bailout tentatively agreed upon in July. Officials are taking pains to avoid a default, which could see the sovereign debt crisis unleashed on other weak and indebted eurozone states like Italy, and could trigger a global banking crisis. Europe's financial institutions remain heavily exposed to eurozone sovereign debt, with French-Belgian bank Dexia (WSJ) already teetering on the brink of collapse.

Greece's announcement is "not news," and was largely expected by policymakers, if not by markets, Daniel Gros, director of the Brussels-based Center for European Policy Studies, told CFR.  EU leaders "will grind their teeth and give Greece the money." Germany, the eurozone member slated to provide the most funding, "doesn't want to be seen as responsible for default," Gros explains. Similarly, Giles Merritt, founder and secretary general of Brussels-based think tank Friends of Europe, told CFR: "Greece has [the troika] over a barrel. No one's going to turn around and say, 'You don't get any more money.' It would be a sure way of having a disastrous default."

However, even with increased rescue funding, Greece is expected to stay in recession through 2012, making it all the more difficult to meet its fiscal targets. European policymakers are increasingly planning for a so-called orderly restructuring, a form of default that could see private investors lose as much as 50 percent of their investments in Greek debt. Greece's new draft budget "suggests that Europe's debt problems have come to a head and that the potential for a Greek managed bankruptcy and major bondholder haircut in the 50 percent range appears increasingly likely," Colin Cieszynski, an analyst at CMC Markets, told Reuters.

Still, it remains unclear when such an event would take place. As Merritt told CFR, there is a significant disconnect between the rapid pace at which markets naturally respond to data and the response time of European bureaucracies. Policymakers have often focused their efforts on the short term, with little regard for the long-term overhaul of EU economic governance that experts agree is needed. But market volatility, coupled with external pressure from the United States and China, has accelerated the urgency of finding a fiscal solution to the debt crisis. European national parliaments are expected to ratify an expansion of the eurozone's temporary bailout mechanism, the European Financial Stability Facility, by the end of the month.

At the end of the day, Merritt says, eurozone leaders understand that the "cost of rescuing the eurozone is nothing compared to the collapse of the eurozone." That, he says, would be "sheer chaos."

Background Materials:

"Bad News from Athens," Der Spiegel

"No Recovery in Sight," DeutscheWelle

"Toil and Trouble," New York Times

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