After issuing a broad statement on February 11 specifying that “Euro area member states will take determined and coordinated action if needed to safeguard stability in the euro area as a whole,” EU leaders are under pressure to spell out the details of such support. Eurozone finance ministers met again on Monday February 15, ahead of Tuesday’s EU Summit, and rather than endorsing a rescue program the EU leaders’ stance seems to have hardened. With respect to Greece’s effort to cut this year’s deficit by four percentage points to 8.7% of GDP, EU monetary affairs commissioner Olli Rehn said: “Our view is that risks related to the implementation and macro-economy and markets are materializing—and therefore there is a clear case for additional measures.” The factors leading to such hardened stance include first, the release of the advance Q4 GDP estimate of –0.8% q/q for Greece which puts annual growth at –2% in 2009—much worse than the –1.2% pencilled into the Stability Program. Second, EU leaders face voter backlash at home, especially in Germany, where price stability is priority number one. Bailing out Greece would be tantamount to opening the floodgates to all profligate spenders, the argument goes.
After years of running alternatively private and public sector deficits, Greece needs to implement not only fiscal constraints but also deep structural reforms in order to improve the country’s relative competitiveness and put it on a sustainable growth path. Importantly, Greece is not the only country facing a competitiveness issue—other countries such as Portugal, Spain, Ireland, and Italy face similar longer-term issues. As Dr. Roubini and Arnab Das note, there are only three ways to restore competitiveness: first, a decade of deflation that leads to a reduction in traded goods prices and domestic private wages; second, an acceleration of structural reforms could increase labor productivity while private and public wage growth is kept in check (this is the path that Germany took in the aftermath of the reunification boom and bust in the early 1990s); third, the euro could weaken—though this still would not solve the intra-EMU competitiveness gap. As the German experience shows, the strucural reform process takes time. Unlike Germany two decades ago, however, Greece faces very high risk premiums on its debt and a potential refinancing crisis if confidence cannot be restored in the next few months.
Besides the technicalities of whether a bilateral or multilateral rescue package could be designed under the EU Treaty’s no bail-out clause (it probably could if the political will can be mustered), the real dilemma is one of moral hazard and of political legitimacy under the current EMU rules. The long history of nations in financing troubles shows that the necessary structural reforms should be accompanied by large and front-loaded financing packages extended under strict conditionality. This would eliminate immediate refinancing fears while the necessary structural reforms are undertaken under close supervision. Given the risk of contagion from Greece to other EMU countries through their banking sectors, for example, the EU or the ECB alone are not in a good position to impose conditionality once a rescue package is implemented. But funding without strict conditionality is the least desirable solution and it has not worked in the past. As Dr. Roubini notes: “This is why a credible IMF program that tranches financial support with the progressive achievement of fiscal and structural reform goals is the right if risky solution. An IMF solution can also better minimize the moral hazard problem than an approach based on loan guarantees.”
(c) RGE Monitor
www.roubini.com
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