Hopes that pledges of new austerity would turn sentiment toward Greece around have proved illusory, and more officials are acknowledging that Greece has to cut its debt, meaning losses for those who hold Greek bonds. But the way forward is immensely complicated, partly because European leaders cannot agree on how much pain to inflict on private-sector bond holders, especially big European banks.
Meanwhile, the European Central Bank continues to demand a response that will not be considered by ratings agencies to be the first default among countries that use the euro, which the bank fears could reduce confidence in the currency’s stability.
It amounts to a game of political and financial chicken, and the markets are becoming fed up with the uncertainty. Investors are now demanding sharply higher interest rates to buy the debt of Italy and Spain — the third- and fourth-largest economies in the euro zone. By doing so they are sending a clear message that Europe has to decide how to absorb the losses necessary to slash Greece’s debt.
Otherwise, the analysts warn, continued confusion about the euro will spread to other weak members of the euro zone, including Italy and Spain, which are considered too big to bail out. Italy alone has debts of 120 percent of its annual gross domestic product, and must refinance nearly a quarter of its debt — nearly 400 billion euros — in the next 18 months. That figure alone is larger than all of Greece’s debt of some 340 billion euros, and at suddenly spiking interest rates of 6 percent or so, even Italy could be teetering toward insolvency.
Officials involved in talks on the new Greek rescue package said that in recent days the debate had moved beyond Greece, and that markets were now questioning the very architecture of the euro, a common currency for sovereign nations with diverse economic and fiscal problems.
“For Spain and Italy, you need to provide a solution for Greece, plus a safety net to prevent contagion,” said Antonio Garcia Pascual, chief southern European economist for Barclays Capital. “But the inaction of policy makers is unhelpful. And we don’t have weeks. It’s a matter of days, especially with Italian and Spanish bonds at this level.”
Until recently, the argument was that any Greek restructuring or default would bring a market frenzy aimed at other countries in difficulty. Instead, the failure to cope with the reality of Greek insolvency has had the opposite effect, causing more contagion, many analysts say.
“To see those yields on highly developed countries like Italy jump so fast has really focused minds,” said Simon Tilford, chief economist for the Center for European Reform in London. Chancellor Angela Merkel of Germany has insisted that there is little urgency and that the private sector must be involved in restructuring.
“Merkel is now in a very difficult position,” Mr. Tilford said. “The Germans are now alive to the risk in ways they weren’t before. For all the derision about Silvio Berlusconi, Italy is core Europe and has very strong ties to Germany and France.”
But those pressing for a comprehensive solution may be disappointed, with Mrs. Merkel saying on Tuesday that “a spectacular, single step cannot responsibly be made, including on Thursday.” Instead, she said, “we need a controlled and manageable process of successive steps and measures” for “reducing debt and improving competitiveness.”
European technocrats are reportedly exploring a tax on euro zone banks to cover burden-sharing by the private sector. They are also said to be considering a supposedly voluntary “rollover” of existing bonds for ones with a lower interest rate and a much longer maturity, preserving, at least notionally, the face value of the bond. That idea, originally French, might not be judged a “default” by all ratings agencies.
Steven Erlanger reported from Paris, and Rachel Donadio from Rome.
Article source: http://www.nytimes.com/2011/07/20/world/europe/20europe.html?partner=rss&emc=rss
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