About 150 people formerly insured with a Greek insurance company that folded last year protest outside the Finance Ministry in central Athens on Monday, April 26, 2010.
When Greek Prime Minister George Papandreou succumbed to the inevitable last week, calling on the International Monetary Fund (IMF) and the euro zone to activate a $60 billion rescue package, he warned that it was a "national and pressing necessity." But as officials descend on Athens to thrash out the mechanics of providing the money, and under what conditions, a grim thought hangs over their heads: are any other national and pressing necessities — in Greece and the euro zone — lurking round the corner?
Although Papandreou strained every sinew of his diplomatic muscle to secure the low-interest loan package, his work is far from done. Before the IMF and Greece's fellow euro zone countries actually disburse their aid, they will expect a credible plan from Greece showing that its austerity measures can redress the country's woeful public finances.
Greece has already outlined plans to cut its deficit to 8.7% in 2010, and to less than 3% by 2012 — drastic enough in good times, but savage when the country is attempting to emerge from recession. These involve a public sector wage freeze, new taxes and a later retirement age — measures that have been met with wildcat strikes and violent protests. And the IMF, which is set to provide around one-third of the loan package, could insist on further cuts, setting the stage for more public unrest.
Within the euro zone, Papandreou will need to pay particular attention to Germany. Chancellor Angela Merkel pledged Monday to support a European financial aid package for Greece, provided "certain conditions" are met. "If Greece is ready to accept tough measures, not just in one year but over several years, then we have a good chance to secure the stability of the euro for us all," she said.
Like the IMF, Merkel wants renewed assurances that Greece will accept additional brutal budgetary cuts over the next few years. German public opinion is fiercely hostile to any sort of bailout — one poll found 86% of Germans were opposed to the package — and even some of Merkel's coalition allies say Greece should consider leaving the euro zone. At the same time, Merkel could face a legal reversal early next month, when Germany's Constitutional Court rules on whether the loans breach the E.U.'s no bailout clause.
This uncertainty was reflected in the markets on Monday, with the cost of insuring Greek debt against default soaring to a record high, and the euro taking a dive against the dollar. "The markets still question the ability of this package to resolve the Greek situation," says Silvio Peruzzo, a London-based analyst at the Royal Bank of Scotland.
But even if Germany and the IMF's anxieties are assuaged, there is no guarantee that the rescue deal will end Greece's malaise, or even stabilize the euro. The loan facility is aimed at ensuring Greece can roll over its debt commitments for another year. Yet the sheer size of the government debt — estimated at $400 billion, or around 120% of GDP, and rising — raises questions about whether any sort of rescue package or austerity program will be enough to turn the tide.
These doubts about Greece's long-term insolvency have spurred speculation about eventual default. Once a taboo subject, economists are increasingly considering circumstances under which Greece might restructure its debt. "The risk of default is always there, and it may be the only solution," says Joachim Scheide, head of the Forecasting Center at the Kiel Institute for the World Economy. "Although the Greeks are doing the best they can, I don't see how else they can reduce the government deficit ratio. At the moment, the chances are about 50-50 that Greece will eventually default."
There are many ways a country can default, one of the most common being a "haircut," in which creditors lose part of the face value of government bonds. Owners of Argentine debt took a 67% writedown in 2005, while in Uruguay in 2003 it was around 13%; some analysts say holders of Greek debt may have to suffer a haircut of half of the value. Another restructuring measure could be to extend the maturity of existing notes by a few years, at the same interest rate.
"A default of some sort — or debt restructuring — is highly likely and people holding government bonds will have to agree to a haircut," says Philip Whyte, senior research fellow at the London-based Center for European Reform think tank. "But given the alternative, that would not be the worst possible outcome, which would be for Greece to leave the euro zone. And for Greece's problems to spread to other vulnerable countries, like Spain and Portugal."
That risk of contagion is perhaps the biggest fear for the euro zone and IMF, as they attempt to forge a deal that staunches Greece's hemorrhaging fiscal crisis. They may agree on a tourniquet over the next few days, but the real question is: when will Greece be able take off its bandages?