Thursday, July 21, 2011

All eyes on the politicians (2)

European leaders are about to meet to discuss the next step in the continuing Greek (indeed Europe) debt saga. We have been somewhat critical of actions taken to-date. They have largely amounted to increasingly austere liquidity measures that have done little to solve what is fundamentally a solvency problem. These measures have variously been described as kicking the issue for touch and kicking the can down the road. All appropriate (but now seriously over-used?) descriptions.

The signs are positive. Possible measures that have been floated prior to this summit include using the European Financial Stability Fund (EFSF) to fund a Greece bond buy-back plan. Such a plan, should it gain favour, could also be used by Portugal and Ireland. This particular measure is favoured by ECB President Jean-Claude Trichet. It would address the fundamental issue that Greek debt is simply too high to be paid back.

Also being discussed will be the extent to which the private sector should participate in the next bailout. Various options put forward by both France and Germany have been threatened by being ruled “selective default” by the rating agencies.

Whatever the measures agreed, we are looking for this next plan to provide a more enduring solution. In hindsight, the initial bailout was too small and it was unrealistic to assume that Greece would be able to return to raising funding in global capital markets as early as next year. As that has become clear, and as politicians have continued to kick the can down the road (sorry, last time, I promise), fears have grown about the debt levels in other European countries, most notably in Italy.

We flagged at the start of the recovery in 2009 that fiscal consolidation was going to be a constraining factor for growth in developed countries with both high structural budget deficits and debt levels. It was, and still is, important that as the plan was constructed in each of those countries, that they achieved the appropriate balance between attaining fiscal sustainability and supporting economic growth. Getting that balance right remains critical. Higher economic growth remains the preferred long-term solution to avoiding default for countries such as Greece.