The financial markets have enthusiastically welcomed the agreements reached in Brussels on Thursday, and understandably so – not only for their immediate content but also for what they signal about how far European leaders are willing to go to finally catch up with the realities of the region’s crisis.
But the feel good factor will only last if this is followed quickly by two other important developments.
First, and most immediate, there is a long list of details that must be specified over the next few weeks to put into practice what was agreed to in Brussels. Many of these are technically very complex. Indeed, implementation may prove as tricky as the original negotiations, if not more so.
How will the reduction of Greek debt actually be executed? Will the banks that need capital be able to find sufficient private funds to meet the new prudential targets? In the event that they do not, what conditions should be attached to the financing coming from taxpayers? How will the European Financial Stability Facility be levered? How will its funds be allocated among competing claims, including between stabilising the old stock of debt and providing partial risk insurance for new issuance? And what roles will the European Central Bank and the International Monetary Fund play, as well as other countries?
Second, and critical for long-term sustainability, Europe must still address two big issues. While these were not scheduled to be addressed in this week’s summit, they must be tackled, and decisively, over the coming months.
Europe desperately needs an effective plan to boost employment and promote inclusive economic growth. Without this, it will be virtually impossible to stabilise the region’s sovereign debt markets, and counter fragilities in its banking system. Bold structural reforms are needed, especially in the peripheral countries but also in the core.
Politicians also need to decide how they will strengthen the institutional underpinnings of the eurozone. Can they deliver a fiscal union with much greater political integration? Or will they be forced to settle for a eurozone consisting of a smaller number of countries with similar initial conditions? Until they answer this basic – basic, but very difficult – question, healthy balance sheets around the world will continue to hesitate to engage in Europe’s recovery.
Policymakers should be commended for the important steps that they took this week. They shifted the emphasis from focusing on liquidity to solvency; and from ad hoc measures, to more comprehensive ones.
But to succeed in the longer term, they must do more than just transform these recent agreements into detailed measures. Indeed, crucial inflows of fresh capital from the private sector and from outside Europe will only materialise in size if the big issues are also resolved.
If any of this is to happen, the region’s leaders will soon find themselves engaged in yet another set of difficult, long, and uncertain negotiations.
The writer is the chief executive and co-chief investment officer of Pimco.
Thursday’s agreement marks a political sea-change
It is easy to be cynical about the responses of European Union leaders. Their track-record in the two years since the Greek crisis first erupted is hardly encouraging. Nevertheless, the agreements reached earlier this week are, as Mohamed El-Erian states, greatly to be welcomed. While he is correct to sound a note of caution about the details, it is important to recognise that a political sea-change has been achieved, which can now be the basis for a credible way out of the crisis that has been weighing on the eurozone.
It is important also to distinguish between the huge uncertainty about whether or not the euro has a future, and the risk that there will still be specific problems. Crucially, the uncertainty that has been so damaging to investor confidence should now abate, because Thursday’s deal should reassure markets that the euro is here to stay and that scenarios of default or break-up can be greatly down-played, if not dismissed outright.
There are undoubted risks and they have to be taken seriously, but they are predictable and can be managed. Difficulties are bound to arise as the details of the package are negotiated. Few will be surprised if there are episodes of brinkmanship or attempts by political groups or other interests to extract a price for cooperation. Similarly, the chances are high that individual governments will not live up fully to their commitments to timely structural reform. But the foot-draggers will now know that they cannot easily hide and that they will be severely punished, whether by electorates that have had enough of vacillation or by markets.
There are still plenty of questions to be addressed about the longer term development of eurozone governance, notably around whether mutualisation of debt becomes fully-fledged eurobonds. This week’s deal is, however, a political breakthrough and demonstrates that the politicians have at last confronted the threats facing the EU and the eurozone. To coin a phrase, this time is different.
The writer is professorial research fellow at the European Institute at the London School of Economics and Political Science.