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| Massive attack |
| Pierre Briancon & Neil Unmack / May 11, 2010, 00:33 IST |
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Euro zone bailout: The euro zone has gone for the big numbers — and it works, at least for now. European Union leaders and their finance ministers have come up with a 720 billion plan to stop contagion in sovereign debt. The European Central Bank has agreed to play ball, and will add sovereign bond-buying to its crisis-fighting tool box. The central bank is also spraying liquidity at the banks to stop the sovereign crisis turning into a new banking one.
To address concerns that their actions play with moral-hazard fire, EU leaders have made any aid to troubled economies conditional on fiscal and structural reforms. The International Monetary Fund will play a major role in any rescue, sending a strong signal that bailout money will only be dispensed with bitter medicine. And the ECB has made clear that it has only agreed to bond-buying because member countries have pledged to meet their fiscal targets. This is a serious and welcome plan. But it's only the opening act of what will be a difficult adjustment period.
In the short run, there has been a dramatic relief rally. The euro has rebounded, as have stock markets. The pressure has also been taken off both weak countries and banks. Spreads on ten-year Portuguese bonds, for example, fell by more than a third. And there was a major easing on the interbank market, with bank credit default swaps falling sharply and bank shares rising up to 20 per cent.
The hope is that Portugal and Spain — which were uncharacteristically singled out in the finance ministers’ communique — will have a breathing space to sort out their fiscal problems without having to access the new bailout funds. They need to come up with serious deficit-reduction measures by May 18. That will be the first test. Spain’s early offer — cutting its deficit by an extra 0.5 per cent of GDP this year, and 1 per cent next year — looks timid so far. But even if Portugal and Spain — as well as other fiscally-challenged southern countries — come up with credible plans to restore budget discipline, that won’t be enough to secure the euro zone’s long-term stability. France and Germany, which all but killed euro zone discipline six years ago by refusing to accept it for themselves, will have to show they are willing to abide by the same framework as their southern brethren. And implement the same type of structural reforms — including the public sector and pension systems — that they are demanding from others.
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