EUROZONE IN CRISIS: Policy failure

European authorities last week took unprecedented action to stem contagion from Greece’s debt crisis and prevent a break-up of the eurozone. But deeper questions about the single currency’s future remain unanswered, while euro hopefuls have begun to doubt the merits of joining an increasingly imperilled currency union

  • By Phil Thornton
  • 15 May 2010
Email a colleague
Request a PDF

Policy-makers across central and eastern Europe can be forgiven for feeling a hint of schadenfreude when they look at the travails of their western neighbours.

A year ago financial markets were betting on which CEE government would be the next to seek help from the IMF. Twelve months later and bets are on which of the so-called eurozone PIGS – Portugal, Ireland and Spain – will follow Greece in seeking an IMF bailout to avert default.

But one of the ironies of financial globalization is that systemic failure for the euro could wreak havoc on CEE countries. As significantly, the crisis has dampened the enthusiasm among countries for joining a currency union that has lost its lustre.

According to leading economists, a crisis in western Europe would deliver a double whammy to the EBRD region in the form of a slump in economic demand and a fresh banking crisis.

Willem Buiter, a former chief economist of the EBRD, says CEE countries will be affected despite having stronger sovereign debt positions. “They should be worried about the health of the European banking system,” he told Emerging Markets while on a visit to Athens. “That’s the main thing. Their banks are largely branches or subsidiaries of western European banks, and a lot of those are still in a very bad shape.”

The threat of a hit to economic growth is equally worrying. The Economist Intelligence Unit (EIU) expects the eurozone to post GDP growth of just 0.8% this year, worse than any comparable region. The main reason is that “fiscal consolidation”– tax hikes and spending cuts – undertaken by Greece and other, larger economies, to cut their deficits will act as a drag on growth.

While Greece itself accounts for less than 3% of eurozone GDP, the concern is that the state of the public finances in other member countries is “too fragile for comfort”, according to the EIU. This has manifested itself in a blowout in the premium governments must pay investors to take on their debt when compared with the interest rate on the benchmark German bund.

While Greece’s 10-year bond spread peaked at 852 basis points (or 8.52%) just before the EU/IMF bailout, Portugal was not far behind on 2.84% while Irish, Italian and Spanish spreads have all risen. Until last November the spread on Greek debt over the previous five years had averaged 0.65%.

This points to the nub of the issue: while the euro protects its members from currency attacks, markets will find other ways to punish them for policy failures.

Jan Randolph, director of Sovereign Risk Country Analysis at IHS Global Insight, says the problem for the PIGS is not just high public debt but large private debt taken on after they joined the euro. “At that point their interest rate migrated down to the German level, and they benefited from a triple-A credit rating,” he says. “So everyone embarks on this big party, asset prices go up and households take on heavy debt burdens.”

The ensuing slowdown in growth will harm the prospects for the eurozone’s eastern neighbours. “Growth in the eurozone is incredibly important for our region,” Erik Berglof, chief economist of the EBRD, says. “Local business sentiment is so closely tied to what is happening in the eurozone. The euro area will have a slower, more fragile recovery than many other parts of the world, and that is what is affecting our region negatively. It dominates any other factor.”


But all economies recover from downturns – eventually. The larger question is whether the Greek drama has undermined the whole single currency project. “The euro has been damaged by the [crisis] as a broad project and has shown some weaknesses,” Berglof says.

Others are gloomier. Stephen Lewis, chief economist at brokerage Monument Securities, believes a break-up of the eurozone is the only “logical development”. “The argument regarding whether the eurozone is an optimal currency area has been settled: it is not, and that has serious implications,” he says.

At the heart of the problem is the public row between Germany and France, the largest countries in the zone, over how to resolve the issue of countries that got into fiscal difficulties. Germany insisted the IMF be part of a bailout to ensure that the money came for Greece with the sort of tough terms on budget cuts the IMF traditionally applies to a troubled emerging market. France on the other hand wanted a euro-led aid package to allow Greece to get its house in order without disturbing the unity and reputation of the eurozone.

Germany won a partial victory, with the result that Greece secured a E110 billion bailout on 2 May that included E30 billion from the IMF and much tougher conditions than originally envisaged by EU leaders.

Lewis sees the eurozone ultimately splitting into a “hard” euro area led by Germany and a “soft” euro tilted towards the southern states. “One can imagine the Czechs feeling that their economy was so tightly meshed with Germany’s that it should enter a union with a hard euro,” he tells Emerging Markets. “Others might see themselves better aligned with a soft euro.”

He says the only alternative is for the zone to “struggle on” for years with member states becoming “impoverished” as they go through reforms aimed at reducing their labour costs to German levels.

Jan Randolph says Greece and Portugal’s debt problems have become an “existential question” for the euro. “Europe is having an identity crisis,” he tells Emerging Markets. “If you were a policy-maker in eastern Europe, you would be watching very carefully because the crisis is testing what the euro means in terms of solidarity.

“Since the Second World War, Germany has always bankrolled integration as it pursued bigger goals of reunification. But this time it is almost as if they are saying ‘we’ve got what we wanted, and now we are not going to pick up the bill or be the final bulwark behind these defaults’.”

Simon Johnson, a former chief economist at the IMF, points out that Ireland and Italy must be kicking themselves for embarking on austerity measures rather than waiting for a bailout. “There seems to be no logic in the system, but perhaps there is a logical outcome. Europe will eventually grow tired of bailing out its weaker countries,” he says. “When the plug is finally pulled, at least one nation will end up in a painful default. Unfortunately, the way we are heading, the problems could be even more widespread.”

Johnson says that if crisis takes hold it would be too large for the European Central Bank or the German government to solve. “The eurozone will be at risk of collapse,” he says. He estimates a bailout of the four weakest economies – Greece, Portugal, Spain and Italy – could cost $1 trillion.


Berglof plays down fears of a collapse of the eurozone but agrees its recent troubles have altered the way it is seen by its neighbours. “The whole region is going through a reassessment of the euro in the sense that, particularly early on, there was this feeling that being part of the euro was a very important protection when the global crisis hit,” he says.

The fact that countries closely tied to the euro seemed to withstand better the impact of the crisis actually fuelled moves to speed up the entry process, he says. “What has happened now that people are a little bit further away from the precipice, is that it has dawned on them that actually there was some advantage to have the flexibility of an exchange rate,” he says. “For the countries that did have the flexibility, they used it to some effect. Poland is the primary example, but Hungary and the Czech Republic benefited to some extent.”

The problems hitting Greece and Portugal have reminded countries they must ensure that they do not join prematurely and that they join at the right exchange rate. “That debate will not go away and will have got new fire,” Berglof says. “That debate has come back in a sense because we have seen some of the dangers of joining too early or joining at the wrong exchange rate.”

The first major test of the region’s warmth towards the region will be Estonia’s application to join the single currency. Its government has taken very tough measures to meet criteria on budget deficits, public debt, inflation, long-term interest rates and currency stability.

The European Commission and the European Central Bank are expected imminently to release an assessment result on Estonia’s eligibility for membership. If the result is positive, the EU Summit will make the political decision on it in June. “In principle the view that has emerged is that Estonia is ready for accession, and I think it is incredibly important for the role of the project of euro accession in our region that Estonia is not denied membership,” says Berglof.

However, it hardly looks like a frantic race to the finishing line. Latvia and Lithuania are on track for membership in 2014 while Poland, which once pencilled in 2012, now sees 2015 as the earliest date.

Randolph says there has been a marked waning of enthusiasm. “A lot of policy-makers in eastern Europe – Poland, Latvia, Romania, etc. – thought they had the assumption that they wanted to be a member of the euro,” he says. “What has happened with Greece has got them thinking that the benefits are not as clear as they thought.”

The reality is that euro accession is less sexy than achieving membership of the European Union. “EU accession was broadly very popular,” says Berglof. “There was a political aspect and a dignity aspect, and it touched people’s lives in so many different dimensions so people were broadly behind it. The euro has never been like that as the euro was held by a small narrow technocratic elite.”

But he insists that people also realize that “actually the euro is quite important” whether for their business or for the interest rate on their apartment. “If we can today make sure that we create certainty about this process, about what needs to be done, and if they do what they are asked to do, then they will become members at a certain point in time.”

  • By Phil Thornton
  • 15 May 2010

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 Citi 244,235.70 910 8.87%
2 JPMorgan 223,767.95 1021 8.13%
3 Bank of America Merrill Lynch 211,276.97 750 7.68%
4 Barclays 166,062.82 634 6.03%
5 Goldman Sachs 162,877.27 537 5.92%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 25,385.87 103 7.10%
2 Deutsche Bank 25,125.19 81 7.03%
3 Bank of America Merrill Lynch 22,023.57 59 6.16%
4 BNP Paribas 18,766.65 109 5.25%
5 Credit Agricole CIB 18,157.63 105 5.08%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 JPMorgan 12,578.87 55 8.17%
2 Citi 11,338.07 71 7.36%
3 UBS 10,682.06 44 6.93%
4 Goldman Sachs 10,419.53 53 6.76%
5 Morgan Stanley 10,194.88 57 6.62%