July 22nd, 2011
05:22 PM GMT
The fractured 17-nation eurozone is heading toward the first default of one its members after Greece was last night forced to accept its second bailout in the face of an overwhelming mountain of debt.
The EUR109 billion bailout, which follows last May’s EUR110 billion bailout, introduces new measures including extensions on the time allowed for Greece to pay back its debts, decreased interest rates and a financial hit for private sector investors, who were previously regarded as sacrosanct.
Yet European markets bounced, showing relief that some political leadership and clarity was being shown in the ongoing saga of Greece’s economic failings. And an orderly default – triggered by private investors voluntarily taking hits to the value of the debt to avoid potentially worse losses later — appears a workable outcome in a desperate situation.
According to Europe’s leaders, the deal for Greece is an “exceptional and unique” solution. These statements have to be made: Confidence is a vital ingredient in any emergence from this crisis. Weaning Greece, Ireland and Portugal off their reliance on the IMF and eurozone bail-out funds requires the return of twitchy private investors.
But noise is already growing that the Greek template could prove a precedent for other eurozone countries.
Ratings agencies – which have butted heads with European politicians over their active downgrading of European countries’ debt – on Friday moved to detail their take on the Greek bailout’s terms.
Fitch Ratings was first to clarify its position, saying the deal’s introduction of private sector involvement will qualify as a “Restricted Default”, a technical term reflecting expectations the country will now default on some of its financial obligations. Other agencies are likely to follow, with a statement from Moody’s Friday noting it is still analysing the measures.
In large, the bail-out is positive, according to Fitch managing director Tony Stringer, who notes it “reduces the potential for uncertainty and underlines there is a concerted political will to address the debt problem and continue to support the weaker members of the eurozone.”
In its statement, Fitch noted if Irish and Portuguese economies were not on a firm footing by 2013, “the potential precedent set… in the Greek package will be incorporated into Fitch's assessment of the risks to bondholders.”
Stringer says the statement is designed to present a balanced view of potential risk, should the Irish and Portuguese economic programs go off track.
Yet the agency has, through its comments, thrown attention forward to the bloc’s other fragile economies, afloat only by virtue of IMF and EU loans.
“It surprised me that Fitch pointed [the likely precedent] out straight away,” Gary Jenkins, head of fixed income at Evolution securities, says. “I didn’t think the ratings agencies would be quite so aggressive.”
Yet the reality appears apparent, according to Jenkins: “Clearly [the European leaders] are desperate to stop contagion, but does anyone really believe that if Portugal or Ireland needed a further bailout that they would not use the Greek template?”
And so the bloc may have flagged a potential shift in its financial structure, to one in which investors in the weaker economies should be prepared to take losses.
It is not known if investors beyond Greece will be forced to take hits. But the road ahead is unclear. And in the words of Commerzbank economist Peter Dixon : “This is the final solution of the crisis until the next one.”
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