EU leaders hurt confidence with vague Greek pledge

World  |  Crisis in Credit

By declaring they would "take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole," the leaders signalled they would prevent any debt default by Greece or other southern states.

But the statement did little to convince investors that the European Union could fix the flaw in the way it operates that led to the Greek crisis: its inability to enforce fiscal discipline among its members.

As long as this flaw remains, investors may fear the euro zone's rich states, such as Germany and France, will end up on the hook to support countries like Greece financially. Such aid could keep the zone together, but at the price of weakening it.

And the vagueness of Thursday's statement, after days of talks within and among European governments on how to handle Greece, suggested the leaders might still be finding it difficult to agree on any specific aid steps.

"The reality is that there was nothing but empty words in this 'accord' and words that further damaged the credibility of both the EU and probably also the Euro," Howard Wheeldon, senior strategist at BGC Brokers in London.

"I am left to conclude that what we have in front of us now is little more than wishful thinking on the part of a handful of albeit powerful EU leaders -- in other words a neat piece of spin aimed at pushing markets off the Greek crisis scent. If so it will fail."

MARKETS

EU sources indicated a range of possible steps to aid Greece had been discussed among officials, from loan guarantees extended by rich EU states to having a German state-owned development bank buy Greek government bonds.

But in the end, no specific action was announced -- which may have been due not only to lack of agreement between EU member states, but also to indecision and disagreements between politicians and ruling parties within states such as Germany.

While some EU sources said details of assistance could be finalised early next week, when EU finance ministers are due to hold a regular meeting, this may also be too optimistic.

The EU leaders' statement did not commit to any deadline for action, and gave the impression that the EU was hoping Greece might still be able to resolve its debt problems without aid. The European Commission will monitor Greece's progress and conduct a "first assessment" in March, the statement said.

In the meantime this leaves open the possibility of the markets resuming heavy selling of the euro and Greek government debt, if economic conditions in Greece worsen and fresh questions arise about the EU's policymaking unity.

A test of the markets' faith in the EU's pledge could come between April 20 and May 19, when Athens will need to pay off about 19 billion euros in maturing debt.

"As things stand, we doubt that today's pronouncements will provide the markets with the re-assurances they were hoping for," said Jonathan Loynes, analyst at Capital Economics.

The euro initially rose against the dollar in response to EU President Herman van Rompuy's announcement that leaders had agreed on Greece, but after just three minutes resumed falling to near eight-month lows.

The spread of the 10-year Greek government bond yield over the benchmark German yield narrowed only slightly, to around 275 basis points from 283 bps a day earlier. It is down from last month's peak of 405 bps, but still far above levels below 100 bps enjoyed by stronger EU states.

MORAL HAZARD

While markets could react badly if Greece does not obtain concrete EU aid, investors may also downgrade the euro zone if Greece does get help.

The zone's members, including Germany and France, have broken budget rules repeatedly in the past decade. But extending aid to a country that has violated the rules so flamboyantly would further undermine the Growth and Stability Pact which is supposed to prevent weak states from abusing their membership of the zone at the expense of strong ones.

The EU leaders' statement did contain one innovation which could please financial markets: the involvement of the International Monetary Fund, which has a reputation for exerting strong pressure on countries to reform their finances.

The European Commission said it would "propose needed additional measures" for Greece to cut its budget deficit, "drawing on the expertise of the IMF."

But if Greece is given aid, the political will within the country to take tough austerity measures may fade, and it is unclear if the EU can threaten Athens with new sanctions that are harsh enough to compel fiscal discipline.

The Greek government is facing a string of one-day strikes by public and private sector unions protesting against austerity measures.

Also, the EU statement did not address another contributing factor to the Greek crisis: the wide divergence in economic performances within the euro zone, which makes membership of the single currency painful to the weakest states.

Van Rompuy said he and some other leaders emphasised the need to reduce such tensions by coordinating national economic policies. But he did not provide specifics, and agreeing on more coordination could be difficult for the 16-member euro zone.

"There really has to be far stronger coordination at a macroeconomic level so as to avoid the situation such as we have ... now, and it's also important that there is far stronger coordination in terms of ... strategy," Van Rompuy said.