Europe must use borrowed time well

Financial Times
Editorial
April 20, 2011

Extraordinary as the eurozone’s efforts to fight the sovereign debt crisis have been, all they have so far achieved is to postpone a resolution. Events will soon impose their own solutions if policymakers do not act more decisively than they have yet been able to contemplate. They can still buy some time – but it must be wisely used.

The inadequacy of the main crisis management tool – a European financial stability facility that extends loans to troubled sovereigns – was exposed both times its help has been called on. Neither the Irish rescue package nor Portugal’s request for one did anything to calm sovereign bond markets. Nor has the EFSF’s prototype – the International Monetary Fund-supported programme for Greece – managed to return Athens to debt markets beyond the very short term. Yields on Greek three-year debt now exceed 21 per cent. George Papaconstantinou, finance minister, admits that it looks difficult to raise as much on private markets next year as the IMF programme stipulates.

This was not how things were meant to turn out. The Greek rescue, and then EFSF, were aimed at convincing markets that the eurozone had confidence in the ability of its troubled periphery to service its debt. Second, that it was willing to put up the money to back this confidence, so that private investors could continue lending without fearing for their investments.

That goal is still worth pursuing. The peripheral trouble is in good part caused by countries’ excessive borrowing. But it also reflects herd behaviour in financial markets. Investors fearing that a state cannot refinance itself on bearable terms will drive up yields and make their own fears come true. It is irresponsible to let this market failure run its course. Solvency is a function of interest cost, and it is the rate at which a country can borrow, not just what private markets are willing to lend at, that determines whether its debt is sustainable. Greek solvency is still within the eurozone’s grasp.

More