For Greece, itís bailout; but for Europe may be just an illusion

Feb 22 2012, 23:26 IST
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SummaryEven after European leaders appeared to have averted a chaotic default by Greece with an eleventh-hour deal for aid, worries persist that a debt disaster on the continent has merely been delayed.

Even after European leaders appeared to have averted a chaotic default by Greece with an eleventh-hour deal for aid, worries persist that a debt disaster on the continent has merely been delayed.

The tortured process that culminated in that latest bailout has exposed the severe limitations of Europeís approach to the crisis. Many fear that policy makers simply donít have the right tools to deal with other troubled countries like Italy, Spain, Ireland and Portugal, a situation that could weigh on the markets and the broader economy.

ďI donít want to be a Cassandra, but the idea that itís over is an illusion,Ē said Kenneth S Rogoff, a professor of economics at Harvard and co-author of ďThis Time Is Different: Eight Centuries of Financial Folly.Ē ďI am amazed by the short-term psychology in the market.Ē

Throughout the crisis, the European Unionís favoured strategy has been to provide tightly controlled financial support to highly indebted countries, in the hope of buying them enough time to put in place policies aimed at cutting budget deficits. While such moves can deepen recessions, the goal is to eventually lower debt levels and win back the confidence of the bond markets.

On the margins, investors have become more optimistic. European stocks and government bonds have rallied sharply this year on the belief that Greece would avoid a disorderly exit from the euro. On Tuesday, United States equities rose slightly after the Greek deal, while European stocks fell modestly, giving up some of their gains from the previous day.

But Greeceís predicament highlights the weakness in the European response. Austerity policies imposed by the authorities contributed to a sharp contraction of the Greek economy last year. In 2010, the International Monetary Fund had forecast that the economy would shrink only 2.6% in 2011, but current estimates suggest a contraction of 6.8%.

Greece is also resorting to a move that European officials initially wanted to avoid at all costs. As part of the 130 billion euro aid package, the country is going to reduce its overall debt load by requiring some creditors to take losses on Greek bonds. In total, the restructuring will mean private sector holders of Greek bonds take a hit of more than 70%.

European officials want to avoid similar measures for other countries. Last year, after European officials suggested debt restructurings might be employed beyond Greece, the regionís government bonds plunged in price. The market reaction prompted officials to remove

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