Doubts linger about EU debt package

While last week’s stunning $1 trillion rescue package for heavily indebted members of the European Union initially helped calm gyrating global markets, doubts resurfaced quickly over whether the plan will suffice to solve Europe’s monumental financial problems.

By the end of the week, stock markets were in decline again from Wall Street to Tokyo and the euro currency had dropped to a 19-month low against the U.S. dollar as investors focused on the many things that can go wrong and prevent the plan from succeeding.

The package of loans and loan guarantees drawn up by the European Union and International Monetary Fund sufficed to put off any immediate concerns about default by Greece, Spain, Portugal, Ireland or Italy — the countries considered most likely to have to eventually draw on the loans to avoid missing payments on their public debts, analysts said.

Thus, the plan essentially bought time for those countries to try to get their budget deficits under control with often painful and unpopular spending cuts and tax increases. Spain and Portugal within hours of the plan’s announcement outlined new measures they were prepared to take to cut their deficits.

The EU’s chief representative at the IMF, Marek Belka, described the rescue plan as “a kind of morphine that stabilizes the patient,” with “the real treatment yet to come.”

But unless European governments follow through with the politically and economically painful budget cuts they promised — sometimes over the heads of protesting citizens — economists warn that the whole plan could come unraveled and lead to a renewed crisis in Europe.

“The real problem is that Europeans are not ready for the reforms they need, and politicians have not clearly explained the severity of the situation to their citizens,” said Moises Naim, analyst at the Carnegie Endowment for International Peace.

“Europeans must realize that, unless Europe moves forward with the necessary and deeply unpopular reforms, the newly available money will do little to save them.”

He estimates that the $1 trillion borrowing facility gives the indebted nations on Europe’s southern rim about a year and a half to resolve their underlying budget problems before markets start to question once again whether they will be able to repay their debts.

Greece and the other debt-laden countries are under the gun to swallow a distasteful mix of measures ranging from freezing government wages and cutting pensions to reining in private employee wages in order to overcome chronic problems with productivity and competitiveness that have been holding back growth in their economies, he said.

Mr. Naim ultimately expects that Greece and possibly some other European countries will be unable to solve their financial problems through budget austerity alone, and will end up having to restructure their debts in a kind of selective default that forces the nations’ lenders to “take a hit” as well.

Deutsche Bank Chief Executive Officer Josef Ackermann rattled global markets Friday when he warned it would take an “incredible effort” for Greece to pay back its debts in full. According to German media reports Sunday, those doubts are shared by Deutsche Bank’s chief economist, Ulrich Kater, who called an orderly repayment “very, very difficult.”

“The austerity measures are meeting with fierce resistance, which is creating a feeling of uneasiness and uncertainty” in the markets, said Tyson Wright, senior trader at Custom House, a Canadian foreign exchange firm.

But investors are also worried that Europe faces a troubling dilemma, even if governments succeed in imposing deep budget cuts, he said, because that could endanger the already paltry economic growth rate of under 1 percent in Europe.

“The fiscal austerity measures announced by Spain and Portugal over the past week reinforced concerns about European growth momentum,” said Brian Bethune, economist at IHS Global Insight.

“The apparent European quagmire is distressing in terms of the outlook for domestic growth in Europe,” he said. But the threat to economic growth as governments curb income payments and withdraw stimulus programs is offset at least some by the big drop in the euro of over 15 percent since the beginning of the year, he said.

The currency’s decline against the dollar and other currencies makes stricken European nations like Greece and Italy more attractive as tourist destinations, while boosting the appeal of their exports, thereby helping their economies to grow.

That is one way the crisis is proving “constructive,” Mr. Bethune said, despite renewed doubts about whether the bailout plan will succeed in containing market mayhem for long.

Paul Robinson, analyst at Barclays Capital, estimates the EU’s combined bailout measures are large enough to meet the funding needs of Greece, Portugal, Spain and Ireland for the next three years, giving them time to work out their budget problems.

“The package was very helpful, but it did not change the underlying issues — the deficits still need to be reduced and competitiveness in these economies has to improve,” he said.

While the bailout prevented a “very bad outcome” in global markets last week, he said, “we think the market is likely to take a progressively dimmer view on the long-term problems.”