Thursday, October 27, 2011

Some progress in Europe...finally

For the first time since the European debt crisis emerged, European leaders have today announced plans that start to head in the direction of a sustainable solution. The key components of the package include a 50% “haircut” for private investors in Greek bonds, a recapitalisation program for the banks and a scaling up of the remaining funds of the EFSF (around €200-250bn) to €1000bn.

We have long highlighted the three elements of the plan as being essential in tackling the fundamental problem of Greek solvency and containing the impact of an inevitable write down of Greek debt. Increasingly austere near-term budget measures were simply pushing Greece (and others) into deeper recession. This was never going to lead to a long-term solution.

In taking this approach, the balance was lost between finding a pathway to fiscal sustainability and supporting economic growth. Indeed building higher sustainable growth remains a key component of the long-term solution to reducing structural budget deficits and debt levels across the developed world.

Much of the detail of the plan is sketchy and some of the assumptions are somewhat optimistic. For example, Greece is required to raise a further €15b in asset sales to repay into the EFSF. This is on top of what was, in our view, an already optimistic €50b privatisation program. It will also remain to be seen whether the estimated €106b required for bank recapitalisation will be sufficient. In terms of the EFSF, it is uncertain how it will be scaled-up and whether €1000b will be enough.

So the details need considerable work, but we now have the key elements of a framework to address Europe’s debt issues. We still have to worry about politics however: there are still some hard calls to be made. Let’s also remember that fiscal austerity is going to be a key feature of the economic landscape in many countries for many years. But hopefully policymakers take the opportunity to strike a more appropriate balance between achieving fiscal sustainability and supporting economic growth.