Eurozone Agrees Second Greek Rescue Deal

Following a marathon meeting in Brussels, Eurozone finance ministers—known collectively as the Eurogroup—have today (21 February) agreed to provide Greece with a second rescue package. In principle, the new bailout will be for EUR130 billion (USD173 billion), although the final size of the package will be decided in March once the results of the private sector involvement (PSI) are known, and will run until 2014. The IMF is expected to contribute around one third of the funds.

Today's decision follows Greece's approval last week of further austerity measures worth EUR3.3 billion—including the identification of EUR325 million in spending cuts to close a fiscal gap this year—and the written commitment sent by the leaders of the two main parties, pledging to implement these measures even after the general election likely to be in April. The final approval of the rescue package is still conditional to a successful resolution of the PSI, while the deal will also have to be approved by several Eurozone parliaments.

What Has Been Agreed

According to a statement released by the Eurogroup, the following points have been agreed:

• The "troika" of lenders—comprising the EU, the ECB and the IMF—will have an "enhanced and permanent presence" on the ground in Greece, aimed to increase its capacity and provide technical assistance, and ensure the "timely and full implementation" of the programme. This has been a demand of some Eurozone "hardliners", particularly the Netherlands.
• Greece will put in place a mechanism to improve the monitoring of the funds destined to be used to service debt. This will include official lending and domestically generated funds. Additionally, Greece has committed to create a legal framework—to be included in the constitution—given priority to debt servicing payments.
• The margin charged on official loans to Greece will be retroactively lowered to 150 basis points. This is expected to bring down Greece's debt to GDP ratio by 2.8 percentage points by 2020.
• Private investors will be offered a 53.5% nominal haircut on their holdings of Greek sovereign bonds, although the loss in net present value terms is likely to be around 75%. This aims to reduce Greece's public debt by EUR100 billion by 2020.
• The European Central Bank will also contribute to Greece's debt reduction efforts by foregoing any potential profit stemming from its holdings of Greek sovereign debt—estimated to be around EUR45 billion—until 2020.
• All in all, these measures are estimated to bring Greece's debt-to-GDP ratio to 120.5% by 2020.

Outlook and Implications

The new bailout package, if finally approved, means that the probability of Greece facing bankruptcy in March has decreased significantly. Indeed, without further funds, Greece would have been unable to redeem a bond for EUR14.5 billion maturing on 20 March. A "hard" default in March would have probably resulted in a Greek exit from the Eurozone, with disastrous consequences for the economy and unknown, but potentially devastating, contagion effects for the rest of the area. Positively, lower interest rates on official loans will also help to improve Greece's debt sustainability, while the ECB's decision to forgo the profits stemming from its holdings of Greek debt are likely to put Greece in a stronger position when negotiating with private bondholders.

This Will Not Solve The Crisis

Does this mean that the Greek crisis has been finally solved? Unfortunately, the answer is a categorical "no". The first question is whether participation in the PSI will be large enough. This is not certain, given that a relatively large share of the private debt being negotiated is held by hedge funds and other independent investors, which may not have a strong incentive to take part of the deal. Some reports suggest that the Greek parliament is expected to pass a law obliging all bondholders to take losses. Although this would ensure a large reduction of Greece's debts, it will put a further question mark on the "voluntary" nature of the debt exchange, risking triggering credit default contracts. Moreover, the second bailout means that the proportion of Greek debt held by official institutions will increase significantly, making it more difficult for Greece to attract new investors when it eventually decides to issue new long term debt.

However, the main problem is that, after years of economic contraction, the Eurozone does not seem to realise that Greece's problems will not be solved without a strategy for growth. To illustrate this point, it is worrying to see that the Eurogroup statement, comprising more than 1,100 words, only mentioned the word "growth" twice. The economy is immersed in an "austerity trap", where fiscal austerity and a deep recession feed each other with dire consequences. The unemployment rate has more than doubled in less than four years (half of Greeks aged between 15 and 24 years of age are currently out of work), while tax revenues have actually fallen in 2011 despite the draconian austerity measures put in place. It is undeniable that the country needs to go though structural reforms to achieve sustainable growth rates in the long term. Indeed, the successful implementation of these reforms will be imperative if the country wants to remain in the Eurozone. However, structural reforms will take time to bear their fruits and it is increasingly clear that, without a growth strategy in the short term, the economy will remain in the doldrums for a significant period. Amid this background, it will be extremely difficult for Greece to reduce its large fiscal deficit and meet the targets agreed with its official creditors. As a result, tensions are likely to resurge every time Greece has to secure a new tranche of official funds. Moreover, the longer the economy stays in dire straits, the more likely social and political support for reforms is eroded.

Opposition to Reforms Likely to Increase

With the new bailout deal safely approved, the Greek politicians will now fully concentrate on the snap parliamentary election, expected to be held in April. Amid the pressure of ongoing and unpopular austerity measures and political bickering, the prospects do not look positive, though. Support for the two main parties—the centre-left Panhellenic Socialist Movement (PASOK), and the conservative New Democracy (ND)—is at a historic low, with the two parties polling around 13% and 19%, respectively. Meanwhile, smaller leftist parties, which oppose the bailout and harsh austerity, are gaining support among public. If the current polls prove true when the general election is held, neither the ND nor the PASOK would secure sufficient support to create a majority government. The winning party would be then forced to team up with smaller, radical parties, which would bring uncertainty and instability mid-term. A grand coalition between ND and PASOK cannot be ruled out, but is currently unlikely: the two parties, standing on the different sides of the political spectrum, have too a many differences to overcome as was already demonstrated during their short coalition existence in place since late 2011.

In the coming weeks, the government will also have to cope with mounting public opposition to the austerity measures. Earlier this month, riots flared up in the capital, Athens, and other Greek cities, with thousands joining the protest rallies as the Greek lawmakers (MPs) moved to approve the austerity package required for the bailout deal to be approved. Dozens of buildings were set ablaze and dozens businesses looted (see Eurozone-Greece: 13 February 2012: Greek MPs Approve Crucial Austerity Package As Riots Flare). On Sunday (19 February), thousands of demonstrators staged another anti-austerity protest in Athens. There were reports that demonstrators suffered minor injuries after they clashed with police, while six people were arrested. More such tension could flare up as the Greek MPs move to approve the bailout deal and later on when they start implementing recently-passed cost-cutting measures.