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Viewpoint: The European debt crisis has seen three important developments

The European debt crisis has seen three important developments, of very different nature: the elections in Greece, which confirmed the difficulty in forming a government capable of managing the crisis and to guarantee the continuity of international aid; an acceleration of banking system restructuring in Spain; Mr. Hollande’s election as President of France, which implies some risk, but also the opportunity to improve the economic management of the euro area…...


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          – In the past week, the European debt crisis has seen three new, important developments. The first is without doubt negative: the general election in Greece resulted in a ungovernable Parliament. The success of forces opposed to the austerity measures, but lacking credible alternative plans, has created strong expectations of the Greek crisis reaching a dramatic climax in a matter of months. For the time being, the Eurogroup has given its go-ahead to the payment of 4.2 billion euros of the bailout package tranche due, retaining one billion as a warning of what would happen if the new government opts not to abide by the commitments made by Papademos. Immediate recourse to new elections, in the hope that they will yield a majority capable of governing, would probably reward the more radical formations; therefore, the more moderate parties could ultimately decide to coalesce to avoid a further contraction of their presence in Parliament and an immediate economic disaster. But what would happen if the new majority decided not to comply with the terms of the bailout? At that point, financial aid would in all likeliness be suspended, Greece’s monetary sovereignty be restored, and the country’s debt, including debt towards the ECB, the IMF, and euro area lender countries, would be restructured. Greece (with no currency reserves and a monthly trade deficit of around two billion euros) would take a leap into the unknown, facing real risk of economic activity and foreign trade coming to a standstill. In the euro area, given the loss of the funds already issued, the aim would be to avoid the payment of a large portion of the loans due to be settled by the EFSF as part of the second bailout package, worth 109.1 billion euros.

          – The second important development is the acceleration in the management of the Spanish banking crisis. All the parties involved seem to have acknowledged that without a credible quantification and delimitation of the problem, it will not be possible to restore confidence in Spain. The partial nationalisation of Bankia, the possibility of an independent audit being ordered of the real estate assets of banks, and the new decree, approved today, raising of bank provisions, are three important steps towards accurately quantifying financial requirements and, subsequently, isolating the problem and understanding the size of European aid that will be necessary to achieve stabilisation.

          – Lastly, Francois Hollande’s election as new President of France has upturned European political balances, opening up the possibility of redefining the Franco-German axis responsible for the mismanagement of the crisis in the past few years. The development implies both risks and opportunities. The main risk is that the change could bring about a weakening of control over public accounts, rather than making control more intelligent: such a mistake would be dangerous for France, that could risk an erosion of its credit standing, and could prove fatal for countries, like Italy, which have suffered an interruption of foreign capital inflows. Opportunities include focusing more on the credibility of consolidation plans, confirming emphasis on structural balances rather than on absolute ones, the adoption of shared measures in support of growth, and a strengthening of the structure of financial and economic aid mechanisms. Success is by no means guaranteed, and may even be unlikely in the latter case: many actions require unanimous decisions, and in the euro area a wide majority is not enough to secure change.


          Appendix

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