Drowning In Debt



The turmoil in Greece and the subsequent rout of the euro have rattled global markets and caused a renewed bout of hand-wringing over the stability of the global economy. Some believe the developed markets have sunk into a perpetual bailout cycle.

By Laurence Neville


The two years since the collapse of Lehman Brothers have been punctuated by a series of support measures and bailouts designed to reassure markets and prevent contagion-the latest of which was the announcement in May of a €750 billion ($928 billion) IMF and EU-backed European Financial Stability Mechanism. With growth tepid in many regions and many countries' ability to prop up markets weakening, some observers believe the global economy has become dangerously addicted to government intervention.

"The world is, to some extent, hooked on bailouts and support, and it will be a challenge to wean it off them," confirms Marco Annunziata, chief economist at UniCredit Group. Indeed, as additional countries succumb to investors' fears about their ability to repay debt, the problem appears to be getting worse. In May, Spanish banks were forced to borrow €85.6 billion from the European Central Bank-the highest amount since the launch of the eurozone in 1999-because the international capital markets were no longer prepared to fund them.

Just as with any addiction, the scale of the support measures needed to maintain confidence is becoming ever larger. The €750 billion European Financial Stability Mechanism is described as a "shock and awe" tactic by Annunziata. However, as Simon Ballard, senior credit strategist at RBC Capital, notes, "The markets were beginning to price in some risk of a collapse not only of peripheral Europe but the eurozone as a whole. A game changer was needed in order to allay market fears of a breakdown in the functioning of financial markets."

The package of IMF and EU financing announced for Greece in May totals €110 billion over three years. That amounts to more than 3,200% of Greece's quota in the IMF and is three times larger relatively speaking than the support extended to Hungary in 2009 and five times larger than that extended to Mexico in 1995, the first big IMF support packages. Certainly, Greece's package signals the gravity of its case for the stability of the international monetary system.

Is the Money Running Out?
No one denies that the challenges posed by a potential default by Greece or other European countries are significant or that the limited access to financial markets by Spain's-and some other countries'-banks could be damaging if not offset by the European Central Bank. However, there are increasing concerns over whether individual countries, and even international bodies such as the IMF, will be able to continue to play such a major role in driving the global economic recovery.

Fiscal measures are, of course, only one way in which governments can intervene in the economy, and the jury is still out on how well they have succeeded. "It's important to remember that there is usually a lag of one-to-two years from fiscal action," notes Brian Coulton, head of global economics at Fitch Ratings. "The decision to ease fiscal policy was taken in late 2008 and implemented in 2009, so we are only beginning to feel the effects."

Nevertheless, Coulton says that intervention-in the event of a double-dip recession, for example-should not be more of the same fiscal measures. "While the US and German [governments] could potentially finance another round of stimulus spending, generally governments have pushed their balance sheets as far as they can go," he says. Moreover, for many of the countries most at risk, it is unclear whether further stimulus measures would even be helpful. "Even excluding the fact that there are not the financial resources to finance further stimulus spending in the UK, for example, it cannot be the answer when the requirement is to deleverage," says Jerome Booth, head of research and co-founder at London-based emerging-markets investor Ashmore Investment Management.

In contrast, central banks can keep credit conditions loose for longer, and some central banks retain the ability to take more risk onto their balance sheets. "It is important to remember that government measures put in place to support their financial systems have been relatively inexpensive," notes Annunziata. "Only a tenth of the increase in public-sector debt [that was] incurred during the financial crisis has resulted from the cost of liquidity measures. Liquidity support measures from central banks have been even more important [than those provided by government], and they cannot be withdrawn in the near future."

Meanwhile, the scale of the IMF's Greece package and the European Financial Stability Facility-as well as the €250 billion bailout of Spain that was being mooted as Global Finance went to press-has raised concerns about whether such largesse remains feasible. Ousmene Mandeng, head of public-sector investment advisory at Ashmore, says the IMF has a residual lending capacity of about $570 billion. "Greece's IMF arrangement signals the beginning of the end of available support resources," he says. "Large fiscal packages in advanced economies limit at least its fiscal abilities to provide much additional assistance." Similarly, RBC's Ballard questions where the core eurozone economies will find their €500 billion contribution to the European Financial Stability Mechanism package at a time when their domestic economies are hardly awash with disposable cash.

However, the consensus view is that the IMF's ability to support further intervention-and major economies' ability to fulfill their IMF and other obligations-will remain solid. "The creation of the European Financial Stability Facility, which includes bilateral as well as IMF funding, indicates that there is little risk that funds for restructuring will dry up," says Coulton, who believes the scale of the package should provide the breathing space needed by troubled economies. "The figures involved are big-they could enable Portugal, Ireland and Spain to be out of the market until 2012," he says.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing

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