Beware, the Trojans were warned, of Greeks bearing gifts. One has to be just as careful these days of Greeks bearing bonds. The euro 110 billion ($147 billion) bailout package announced jointly by the International Monetary Fund (IMF) and the eurozone countries raises more questions than it answers and, like so many of the policy responses of western governments in the past two years, may well be too little too late. The crisis in Greece was essentially fiscal, but its implications for Greece and the eurozone countries go well beyond the purely economic. The very existence of the eurozone has come under question and the political future of the European Union (EU) is under threat. Germany’s dithering, for domestic political reasons, has cast a long shadow and it remains to be seen how, if not “if”, the EU will survive this crisis. The Greek debt crisis shows clearly that if the eurozone is to come out of this crisis relatively unscathed, it needs a full-time fiscal-monitoring and crisis-resolution mechanism. Apart from better fiscal and trade policy coordination, the eurozone needs institutions that can facilitate policy coordination, rescue and bailout programmes at the region-wide level.
With the Mediterranean economy’s government finances on the brink of collapse, Greece’s sovereign bonds were notched down last week to junk-grade by rating agency Standard and Poor’s. The difference between the yields on German government bonds and Greek bonds (remember they are both part of the eurozone) is a stupendous six-and-a-half percentage points. Greece is a relatively small economy (about 3 per cent of the eurozone) but European banks have large holdings of Greek sovereign bonds on their balance sheets. Besides, by virtue of its membership of the eurozone, it is considered an “advanced” economy. Thus, if the government had reneged on its obligation, the markets may have seen it as the first of its kind by an advanced economy. In short, a default by Greece would have been a big deal.
The bailout of Greece by the EU and the IMF does not end the ongoing saga in Europe. Portugal and Spain are now on the radar. Both have seen downgrades in their credit ratings last week. If the UK has a messy election result, it too could come under a cloud. It remains to be seen how far Europe’s politicians can stretch the “too big to fail” principle and convince the public in solvent economies like Germany to reach into their pockets each time a bankrupt economy passes its hat around.
Fundamentally, the fate of Greece and the other troubled Southern European economies highlights the costs and follies of using massive fiscal stimulus to pump-prime collapsing economies. Since economies across the world followed a similar strategy to battle recession, this episode is likely to raise some uncomfortable questions about the future of the global recovery itself. This is likely to lead to enhanced risk aversion and a search for safe havens. In the panic that came in the wake of Lehman’s collapse, the US government bond market and gold emerged as these safe havens. Investors fled all “risky” asset markets, including the Indian markets, setting off a slide in the stock market and a spike in external borrowing costs for Indian borrowers. The impact on India of the “Greek crisis” depends critically on whether Asia is considered to be the third safe haven this time around. It is possible to argue that the rebound in economies such as China, India and Indonesia in 2009, when the rest of the world was floundering, actually makes a strong case for safe haven status.
