Free exchange | Europe's debt crisis

Counteroffensive

The plan to halt European crisis becomes clear

By R.A. | WASHINGTON

AFTER months of dithering, through which market confidence in a struggling periphery steadily eroded, eventually dragging the economies of Spain and Italy into the gyre, the euro zone has at last prepared its response. While it may not prove sufficient to the task, it is more than many hoped for or expected to get. An emergency Brussels summit has concluded with agreement on a new rescue package for Greece, worth an estimated €109 billion, and a new set of weapons in the battle to limit contagion.

As expected, private creditors of the Greek government will take a hit, contributing €37 billion of the package's total. Bondholders will be given four restructuring options to choose from, a menu that includes a selection of durations and coupon payments. The hit to private lenders will most likely lead to a "selective default" rating from ratings agencies, but the European Central Bank has acquiesced to this outcome. ECB President Jean-Claude Trichet suggested that European governments would likely guarantee Greek bonds in the event of a default rating.

The bail-out programmes for Greece, Ireland, and Portugal would all be amended as a result of the agreement. The interest rates on emergency loans would fall to 3.5% (a drop of 1 to 2 percentage points) and repayment schedules will be lengthened considerably. There was also agreement on a Greek bond buyback programme worth €12.6 billion.

Lastly, expected changes to the European Financial Stability Facility were included in the deal; the EFSF will not receive an increase in funding, but it will be allowed to lend to countries without a bail-out, and it will have the ability to recapitalise struggling banks. It may also get permission to purchase the debt of troubled countries on secondary markets in "exceptional circumstances".

European leaders made sure to assemble sound-bite ready material in calling (somewhat amusingly) for a "European Marshall Plan". This particular plan would apply only to Greece, and, if realised, would entail:

[A] Task Force which will work with the Greek authorities to target the structural funds on competitiveness and growth, job creation and training. We will mobilise EU funds and institutions such as the EIB towards this goal and relaunch the Greek economy. Member States and the Commission will immediately mobilize all resources necessary in order to provide exceptional technical assistance to help Greece implement its reforms.

The new framework covers many of the bases economists suggested should be hit. It reduces Greece's obligations, rather than merely postponing them. It creates a mechanism to support troubled banks. The size of the commitment is likely not sufficient to deter financial panic in the event large European banks are threatened by the potential insolvency of, say, Spain, but it may be enough to limit bank runs within Greece. It gives the EFSF some of the tools necessary to rebuild the firewall between Spain and Italy. And it holds out the hope for a programme of fiscal transfers to Greece, to help its struggling economy endure the austerity necessary to keep it in the euro zone. For now, markets have given the plan a big vote of confidence. Equities and the euro are up; yields on peripheral debt are down.

But already, some are criticising the plan as too timid. The impressive commitment to keep Greece afloat has not yet been matched by a commitment to restructure the debts of Ireland and Portugal, which are also probably insolvent. The failure to boost the resources of the EFSF may reduce the plan's impact on confidence in European banks and in the determination to halt contagion. And the vague "Marshall Plan" portion of the programme is the only nod toward the dire growth outlook across the struggling European periphery. Indeed, the agreement reiterates the euro zone's commitment to rapid reductions by 2013. The combination of continent-wide austerity and a hawkish ECB posture will ensure that euro-zone growth is slow to negative for the next few years. That, in turn, will make life very difficult for the beleaguered periphery. This increases the odds that the stated goals will not be met, and that disappointing performances will precipitate more crises of confidence in markets.

The euro-zone's leaders have done better than many hoped they could, but that is not saying much. This plan may buy the currency area time. But its survival will only be guaranteed if that time is used to continue the process of fiscal integration and reform.

Read on: More on the emergency euro-zone summit from Schumpeter, Charlemagne, and Democracy in America.

(Photo credit: AFP)

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