What Angela isn’t saying: Euro-zone rescues have left sovereign debt too high to be sustainable

What Angela isn’t saying: Euro-zone rescues have left sovereign debt too high to be sustainable

Aug 10th 2013 |From the print edition

AN ORCHESTRATED hush has descended over the euro area as Angela Merkel, the German chancellor who conducts its troubled band of 17 states, campaigns for a third term in the election on September 22nd. The calm also stems from signs that the euro-zone economy may gradually be emerging from recession. But discord will reappear after the poll as it becomes clear that Europe’s bail-out programmes won’t be unwound harmoniously and that more big bills are on their way.

Of the first three rescued euro-zone countries—Greece in the spring of 2010, Ireland at the end of that year and Portugal in mid-2011—only one should be able to leave its bail-out programme as planned. Helped by its resilient economy, Ireland, whose rescue amounted to €67.5 billion ($90 billion), looks set to bow out at the end of this year. In practice, however, it will be only a partial departure.Ireland will then rely on private markets to meet its financing needs rather than on official loans. It will no longer have to comply with harsh fiscal and economic conditions set and monitored by the European authorities and the IMF. But although Ireland has made some successful forays into the capital markets this year it is rightly nervous about standing alone again. This year’s budget deficit remains high, at 7.5% of GDP. Government debt, swollen by a massive injection of public money into Ireland’s banks, has reached 125% of GDP (see chart). The actual burden is higher because a big chunk of GDP comprises lightly-taxed profits made by foreign multinationals; debt as a share of GNP, the part of GDP that goes to Irish residents and the main tax base, is over 150%.

Conscious of its vulnerability, Ireland wants its borrowing to be shielded from bond vigilantes by the European Central Bank (ECB) through its pledge to make potentially unlimited purchases of debt in secondary markets. But the country will be eligible only if it signs up for a precautionary programme with the euro zone’s rescue fund, which will provide a credit line. Although the conditions for this will be lighter than those for a full bail-out, Ireland will still have to be monitored. Moreover, the ECB has said that the IMF should be involved. In short, Ireland will exit from one bail-out programme and enter another.

The Irish departure is supposed to pave the way for Portugal’s exit in mid-2014, again three years after it received a rescue, in its case of €78 billion. But this prospect is now in doubt as a wrenching recession has undermined support for the government led by Pedro Passos Coelho. Although Portugal managed to raise some funds from the markets earlier this year, it has since suffered an acute political crisis, which has weakened its capacity to tackle a budget deficit of 5.5% of GDP this year.

Weighed down by debt, Portugal’s medium-term growth prospects are poor. Public debt has reached 127% of GDP, and the potential burden is higher. The government has big contingent liabilities, arising from guarantees, public-private partnerships and publicly owned firms. These could turn into actual debt: the IMF estimates they could add a further 15% of GDP to the burden, taking the ratio above 140%. Whereas Irish ten-year bond yields are below 4%, Portuguese yields are above 6.5%—too high for so indebted a country. Markets are signalling disbelief that Portugal will avoid some form of second bail-out.

That was the fate of Greece last year, following its original rescue in May 2010. Altogether its two bail-outs have provided €246 billion of rescue financing, bigger than Greek GDP. And yet even more is now necessary: the IMF says that a hole of €4.4 billion will open up in late 2014. Since it can lend only if financing is secure a year ahead, the IMF wants reassurance from the Eurogroup of finance ministers that they will plug the gap. Beyond lies another hole in 2015, of €6.5 billion.

The fundamental problem is that Greek debt is still far too high. Public debt will peak at more than 175% of GDP at the end of this year. The hope is that economic recovery from 2014 together with continuing fiscal stringency will put it on a downward path. But Greece will need more debt relief if it is to hit a target of 124% by 2020. Since Greek debt is now overwhelmingly in official hands and the IMF insists on its loans being repaid, that relief will have to come from the rest of the euro zone. The IMF says that the Eurogroup must provide debt relief worth 4% of GDP (around €7 billion) in 2014-15. And it will have to come up with even more to reach another target, for debt to drop below 110% by 2022.

Beating targets for privatisation revenues would help, but Greece has a terrible record of undershooting them: the goal for this year will be missed by €1 billion. The main answer will have to be debt forgiveness. Europe has already eased debt burdens on bailed-out economies by lowering interest rates on its loans and extending maturities. Greece is getting even more help, receiving for example central-bank profits from buying its bonds. But it is still not enough. That awkward truth, already apparent before the German election, will become manifest after it.