ANALYSIS-After hardball, Greece gets EU solidarity pledges

By Reuters Staff
December 12, 2009

EU High Representative for Foreign Affairs Catherine Ashton (L) poses with Greek Prime Minister George Papandreou during a European Union leaders summit in Brussels December 10, 2009.  REUTERS/Yves Herman By Brian Love, European Economics Correspondent

PARIS, Dec 11 (Reuters) – Reassuring noises from France and Germany suggest Greece can ultimately count on help from its euro zone partners if its debt problems get out of hand — though its partners were content to see financial markets scare Athens for a while.

As Greek bond spreads ballooned early this week, officials in major European Union governments indirectly fuelled the panic by refraining from making clear pledges of support for Greece.

Most of the officials’ public statements focused on urging Athens to face up to its problems and, like Ireland, take drastic steps such as public spending cuts to reduce its budget deficit and prevent its debt from becoming unserviceable.

But since Thursday, European officials have changed tack and indicated they are prepared, if necessary, to act to prevent the fiscal pressures on Greece from growing so heavy that the country might have to pull out from the euro zone.

Some analysts think the EU deliberately used the bond market turmoil to make the Greek government recognise the need to act decisively on its deficit — and then calmed the turmoil before it could become unmanageable and do lasting damage to Greece.

“EU policymakers have played a game of brinkmanship and have nearly fallen off the edge,” said Marco Annunziata, London-based chief economist at UniCredit bank.

“They have gotten scared, but I think they have succeeded in getting Greek policymakers scared too.

“This should set the stage for either a best-case scenario where the Greek government now spontaneously finds the resolve to take tougher measures, or these will be imposed as part of a rescue plan.”

COMMON RESPONSIBILITY

German leader Angela Merkel signalled the EU’s change of tack by saying on Thursday: “What happens in one member state affects all others, especially as we have a common currency, which means we have a common responsibility”.

French finance minister Christine Lagarde confirmed the shift on Friday by declaring the euro currency area was a “monetary zone of complete solidarity”.

Those pledges of support still did not sound as explicit as one made by then-German finance minister Peer Steinbrueck in February, during another period of bond market jitters over the the debt burdens of countries in the euro zone.

“If it came to a serious situation, all of the euro zone countries would have to help,” Steinbrueck said at that time.

Steinbrueck was speaking at the height of the global financial crisis, when a disaster in one euro zone country could have rippled throughout the zone; now that the global crisis has eased, Merkel and Lagarde may feel they have more room to hold back support as they pressure Greece.

Nevertheless, bonds reacted to the statements by Merkel and Lagarde in much the same way that they responded to Steinbrueck; the premium which investors demand to hold 10-year Greek government bonds rather than safer German Bunds shrank dramatically on Friday to 206 basis points, from around 230 late on Thursday. It had hit 267 bps earlier in the week, the biggest premium since April.

A Greek official told Reuters that Greek premier George Papandreou would meet employers and labour unions next week, and then outline a “stability and growth plan, with specific commitments” on cutting the budget deficit.

This raised the possibility that Papandreou, who was visiting Brussels on Friday, might have reached some kind of understanding that Athens would act on its deficit in exchange for declarations of support from Germany and France.

IMPROVISED PROCESS

Some analysts think there remains a good chance that Greece, and possibly other euro zone members, may not be able to solve their fiscal problems by themselves.

“We think that the fault lines that run through the Eurozone are so deep that some form of financial crisis, resulting in bailout or pullout, is likely before the end of 2010,” South Africa’s Standard Bank said in a report on Friday.

But Goldman Sachs economist Erik Nielsen said Greece and the EU might feel their way towards a resolution of the problem through an improvised process in which the EU extended support in stages as and when they became necessary.

In the first stage, which could start as soon as next week, the Greek government would announce new measures to rein in its budget deficit; the EU’s vague declaration of support for Greece would help to make these measures convincing to the markets.

Next, the European Central Bank might need to act if credit rating agencies downgraded Greek debt to a level that would prevent Greek banks from providing collateral to borrow from the ECB as of January 2011, when a temporarily more lenient ECB policy on the quality of collateral is due to expire.

In this scenario, the ECB would have to find an administrative solution that would justify it continuing to accept collateral from downgraded Greek banks.

“We believe it is inconceivable that a sovereign member of the euro system would lose eligibility for collateral,” Nielsen said in a note to clients.

The options from there on would become more drastic, possibly including some form of joint guarantee on Greek debt issuance by other euro zone countries, the issue of some form of euro zone bond to help fund Greece, and the creation of a direct bailout fund to which countries would contribute.

UniCredit’s Annunziata said he believed a form of European rescue fund would be most plausible; the conditions for the bailout would be decided by the EU as a whole, but countries which paid most into the fund would have the greatest say on the conditions.

Solutions such as a common euro zone bond or debt guarantee would be less likely because of their technical complexity and the difficulty in apportioning responsibility clearly to individual nations, he said. (Editing by Andrew Torchia) ((brian.love@reuters.com; +33 1 49495339; Reuters Messaging brian.love@reuters.com@reuters.net))

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