E.U.'s Latest Rescue Package Seen Falling Short-Again

LONDON — Another missed opportunity for Europe?
Over the past year, the European Union and the International Monetary fund have pledged €640 billion in bailout funds to distressed economies on the Continent’s periphery. Yet the interest rates on benchmark bonds in Greece, Ireland and Portugal remain at or near their historic highs.
Pressed yet again by a skeptical market to take action, Europe’s leaders cobbled together a new structure over the weekend that will allow its rescue fund, the European Financial Stability Facility, to disburse its entire €440 billion, or $615 billion, allotment if needed, and to buy bonds at government auctions. They also eased the conditions on Greece’s rescue loans by reducing interest rates and extending repayment terms.
Analysts and investors greeted the effort Monday with cautious approval, as euro zone finance ministers regrouped to work out more details.
But as has often been the case with grand European rescue plans, there appears to be a catch: While the European rescue facility can now buy bonds at government auctions, it will not be able to purchase paper in the secondary market. That will heap more pressure on an ever-reluctant European Central Bank to remain in its job as peripheral Europe’s buyer of last resort.
What is more, the plan states that the fund can buy bonds only from countries that have taken bailout funds, an odd stipulation that means that the country most in need of support at the moment — Portugal — does not get any.
Consequently, pressure on Portuguese 10-year bonds eased only slightly Monday, with interest rates sticking close to the 7.4 percent level at which they have traded for the past few weeks. Greek bonds rallied on the interest rate deal, but Irish bonds made only the smallest move as they did not receive a break on their interest rate. Spanish yields fell to 5.2 percent, still close to their high of 5.4 percent.
“What we have now falls short of what is required, which is a way to bring interest rates down,” said Dirk Hoffman-Becking, a banking analyst at Sanford C. Bernstein in London.
Mr. Hoffman-Becking argued that these persistently high rates only recycled fear and uncertainty via higher funding costs for banks and, ultimately, lower economic growth. He added that unless the E.F.S.F. stepped into the secondary market to buy bonds in large quantities, rates would remain high. That is because private investors remain unwilling to buy given the risk of default and the risk that austerity programs will undermine economic recovery.
Again, the example of Portugal is relevant. Last Friday, the government in Lisbon promised more spending cuts and revenue-raising measures to make good on its promise to bring the budget deficit down to 4.6 percent of gross domestic product, from 7.4 percent this year. But with one of the lowest growth rates in Europe, an uncompetitive export industry and public debt at 80 percent of G.D.P., investors see little upside in buying Portuguese bonds now, even at such wide spreads to comparable German bonds.
For the most part, the E.C.B. has been unwilling to step in aggressively — it has purchased only €77 billion in peripheral-country bonds so far. On Monday, the bank reported that it had not bought any bonds last week, for the second week in a row.
Thus, the lack of a big buyer is expected to keep rates high and continue to feed market unease. And that in many ways remains the unsolved root of Europe’s sovereign debt crisis.
Euro zone governments and the I.M.F. are asking that investors take a leap of faith and accept that the bone-crunching austerity programs in Greece, Ireland and Portugal, underpinned by tax increases and sharp wage reductions, will reduce deficits and ultimately high levels of debt.
But, as a comprehensive new report on the origins of Europe’s debt crisis by the investment bank Nomura points out, what is more likely to happen is that the debt of countries like Greece and Ireland will merely increase in what economists call a snowball effect, as the interest rate on the government’s debt grows faster than their stagnating economies.
That problem will only be compounded when the European Central Bank increases interest rates, which it has warned it will do.
The result is a Catch-22 of sorts: the faster and deeper these countries cut, the slower they grow, with the perverse effect that their debt ends up increasing as opposed to decreasing.
“In the short term, this problem is inevitable — your debt will continue to increase as long as your growth rate is below the interest rate you are paying,” said Peter Westaway, European economist at Nomura in London and one of the authors of the report.
In 2013, for example, Greece’s debt will have increased to almost 160 percent of G.D.P. from 127 percent of G.D.P. And while the country was quick to hail its improved terms, the bottom line still remains that by 2014 it must begin paying interest equivalent to about 8 percent of its G.D.P. — a huge amount by any measure.
For now, Greece has time. But with growth expected to shrink again this year, by 3.4 percent, and with unemployment now at about 15 percent, how long the Greek government, or any government for that matter, can continue to expect so much public sacrifice to pay off its bankers remains to be seen.