>Lessons from the Greek crisis

The fiscal position in the euro zone overall compares favourably with the United States, the United Kingdom and Japan in terms of both the government deficit and debt ratios, and the area has adequate domestic savings, as demonstrated by its balanced external trade accounts. However, the slide in the public finances of a number of countries in the zone led by Greece (Chart 1) has caused a very sharp rise in sovereign debt yields (Chart 2). Portuguese and Spanish bonds have been affected by contagion. Under attack from the markets, Greece has been given explicit support by the European Union: “Euro area members will take determined and coordinated action if needed to safeguard stability in the Eurozone as a whole”. It was defence of the financial stability of the whole euro zone that was stressed in the 27 EU countries’ statement, but the message to the markets, together with support for the Greek government’s current efforts to clean up its public finances, was very clear.

Default is not an option. Default would lead to contagion, causing yields to rise, and to more intense measures to rebuild public finances which would be likely to push the euro zone back into recession. Banking systems, which have in the short term financed the purchase of government securities, would also be affected, not to mention the risk to liquidity that would be created by further downgrades of sovereign ratings (the ECB only accepted paper rated A- before the crisis, but has cut its requirement to BBB+, although it has announced its intention to return to the previous level at the beginning of 2011).

The technical details of any plan have not been disclosed, but would not be without legal and political difficulties (Coordinated bilateral assistance? Early payment of European funds? Bridging loans? Guarantees from national treasuries?). On 16 March, the Greek authorities will have to provide a detailed timetable of the planned measures for reducing the government deficit by 4 points of GDP in 2010, and by about 10 points by 2012, as laid out in the stability and convergence plan approved by the European Commission at the beginning of February. If it looked as if the 4 points of GDP deficit reduction target is not going to be met, additional measures would have to be taken, on terms set by the European Commission, which has felt it necessary to call on the technical skills of the IMF. These arrangements are unprecedented. Greece has now been placed under strict surveillance and any assistance (it should be borne in mind that the Greek authorities have not yet officially asked to be helped) is subject to conditions. What must be avoided is the appearance of a bail out, since this is prohibited by the Maastricht Treaty.

To read the full report: GREEK CRISIS