The EU is running out of choices to tame the crisis

by Panayotis Glavinis

May 6, 2011
[This Report is originally published at GreekCrisis.net]

Last year, the Euro Area faced an unprecedented crisis when sovereign bond markets cut off Greece’s access to debt financing. Since May 2010, Greece is being funded by an ad hoc mechanism set up on a multilateral basis by the IMF and on a bilateral basis by the Euro Area member states.

Europe’s belated reaction vis-à-vis Greece succeeded in containing the crisis only temporarily. One month after Greece’s rescue, markets were severely testing Spain. The Euro Area could not afford to bail out Spain too. The effective lending capacity of the European Financial Stability Facility (EFSF), set up in May with a view to mobilizing financing for rescue purposes until mid-2013, would be insufficient. In November, Ireland requested assistance from the EFSF.

At the end of last year, while it was becoming clear that Portugal would have to tap EFSF too, the Euro Area understood that –for containing the spreading crisis– it could no longer allow markets to count on the deep pocket of its financially strong nations and keep on lending money to its debt ridden periphery no matter how high interest rates would be. It, therefore, embarked on the elaboration of the so-called «comprehensive solution».

Euro Area’s comprehensive solution to the debt crisis

On March 25th, the Euro Area succeeded in setting out a comprehensive package of rules with a view to addressing future debt crises. The new package is governed by a core tripartite contribution approach. Financially strong nations conceded to increase the effective lending capacity of the EFSF and the European Stability Mechanism (ESM), the Euro Area’s permanent support instrument that will succeed to the EFSF after 2013. In exchange, financially weak member states conceded to strengthen their fiscal adjustment policies so as to maintain their creditworthiness. They all agreed, however, that bond holders would also be required to waive part of their claims against a state requesting assistance from the ESM, in case its debt burden would prove unsustainable following a «rigorous» sustainability analysis test. At the same time, the EU adopted a set of increased coordination measures, with a view to enhancing convergence of national economies, and more rigid monitoring procedures, so as to prevent fiscal destabilization at an early stage.

Admittedly, the Euro Area has made significant institutional progress in addressing sovereign debt crises; but only in theory, since the ESM will become operational after 2013, whereas the contagion of the crisis needs to be addressed at the very present moment. For the time being, it seems that Spain –not to mention Italy– has been safely distantiated from the other most vulnerable PIIGS. Apparently, markets did receive Euro Area’s bold message to adopt a more responsible approach vis-à-vis Spain. S&Ps, no less, maintained the country’s high creditworthiness and Spain has been successfully tapping the markets ever since, albeit at an increased borrowing cost. Spanish government also has received the message by demonstrating increased determination to implement more stringent adjustment policies, so as to avoid jeopardizing access to markets. It results that, for the time being, Europe’s new strategy to contain the crisis within the three weaker PIIGS (a rather convenient solution both politically and economically, if sustained) is working.

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Panayotis Glavinis is an Associate Professor of International Economic Law at the Faculty of Law of the Aristotle University of Thessaloniki.