Merkel's retreat ends bitter stand-off but solution to crisis still beyond reach

 

ANALYSIS:While Angela Merkel’s reversal should not be underestimated, it only moves one cog

EURO ZONE finance ministers gathered last night in Luxembourg for another round of emergency talks on the financial and political crisis in Greece. They may be edging towards a new bailout for the country, but the situation is fraught with uncertainty and risk.

The talks, which resume today, will continue into next month. Although EU leaders meet for their summer summit in Brussels on Thursday and Friday, no settlement is expected at that point. The issues are too complex, the interests too diverse, the politics too difficult. In Brussels the mood is gloomy. Similar strain is evident elsewhere.

The latest exchanges follow the capitulation of German chancellor Angela Merkel on the scope of any private creditor participation in any new aid package. The demarche came on Friday amid mounting tension in financial markets over the threat of a Greek debt default. Not for the first time in the 20-month debt saga, the danger of contagion spreading to Spain appears to have spurred Berlin into action.

So where exactly are we now? Although the significance of Merkel’s retreat should not be underestimated, it moves but one cog. Many other elements of the equation remain unclear.

Chief among those is the Greek government’s grinding struggle to win parliamentary approval for a swingeing new round of cutbacks and tax increases. Prime minister George Papandreou faces a confidence motion tomorrow. If he loses, the rescue effort will be in even greater jeopardy.

Europe won’t release rescue loans to Greece if parliament rejects a new austerity plan, but Papandreou’s MPs are under siege as protests escalate against austerity. Scenting blood, the Greek opposition sees little merit in propping Papandreou up via a national unity government.

Greek leaders are coming under increasing pressure. While they need €12 billion next month to avert the threat of default, Belgian minister Didier Reynders last night raised the possibility of the country receiving “a bit less than €6 billion” initially.

Merkel’s reversal all but ends a bitter stand-off with the European Central Bank, but the development raises valid questions as to the effectiveness of looming measures to ease some of the burden on Greece from its mountainous national debt.

Further uncertainty arises as to the political acceptability in Germany of a rescue plan which lets private bondholders off the hook and puts reluctant German taxpayers – yet again – in the line of fire. For weeks, Berlin and the ECB slugged it out over the scope of any initiative to embark on a restructuring of Greek debt.

Germany wanted a debt-swap in which investors would exchange their existing securities with bonds carrying a longer maturity. In Merkel’s eyes, only a “quantified” private sector contribution would be acceptable.

The ECB bridled, fearing such a move would occasion a default “credit event” which would unsettle markets. The chancellor blinked first.

What is now in prospect is a purely voluntary plan mirrored on the 2009 “Vienna Initiative” in which international banks and investors agreed to maintain their exposure to countries in central and eastern Europe in the aftermath of the Lehman explosion in autumn 2008.

Instead of changing the contractual terms of existing Greek debt, investors would be encouraged at their own discretion to renew or roll over their exposure to the country when their bonds mature.

In theory at least, that would lessen some of the load on Athens.

The problem, however, is that investors have already written Greece off. Their lack of confidence in the country – seen in their refusal to lend to it at anything less than penal rates – is a prime force in the crisis.

As fear intensifies that Greece will not be able to repay its debt, investors have more reason to shun the country than to lend to it again. Given all that is going on, it is difficult to make a positive investment case for Greece.

This remains the fundamental dilemma posed by the debacle – and explains why Merkel wanted something which went far beyond purely voluntary measures in the first instance. Would she have felt the need to agitate for that if she felt a voluntary plan was sufficient? Euro group chief Jean-Claude Juncker said at the outset of the talks that incentives for bondholders to participate in the Greek aid package were under discussion. Quite how that would work remains unclear.

Without some element of compulsion, the scope for an appreciable private sector contribution is severely curtailed. With compulsion, however, comes default and the threat of an explosion on the markets. Hence the ECB’s strident opposition to Merkel.

Most analysts – and more than a few politicians – believe Greece will never be able to repay all its debt. But that doesn’t make them any more willing to confront the problem now.

There are no neat answers here, no opportunity for fancy political footwork and little confidence that an acceptable solution is to hand. With notional Irish borrowing costs at record levels, there is little likelihood of any immediate relief.