Bitter Euro Truths: Crisis Could Damage Merkel's Campaign
Chancellor Angela Merkel has been forced to concede that Greece will require additional aid -- an admission that has dented her reputation as a crisis manager ahead of the election. But she still hasn't revealed the true scope of the costs facing Germany.
When a politician is planning a campaign lie, he has to be able to rely on one thing: No one in his own party must come out with the truth prematurely. The Social Democrats adhered to this rule in the 1976 election, when then Chancellor Helmut Schmidt promised higher pensions and then announced sharp cuts after the election. And the center-right Christian Democratic Union (CDU) also closed ranks in 1990, the year of German reunification, when then Chancellor Helmut Kohl appeared on market squares throughout the country to announce that taxes would not be raised. It was a promise that, as we now know, was followed by the strongest postwar increase in taxes and other charges.
But after SPIEGEL had reported two weeks ago that the Bundesbank, Germany's central bank, had new doubts about Greece's bailout program, the debate over additional aid packages or debt forgiveness was reignited. This would be extremely dangerous, the chancellor told CDU MPs, as it would create "uncertainty in the markets." In other words, she was saying, it was critical to maintain discipline in the debate.
Less than 24 hours later, Finance Minister Wolfgang Schäuble appeared on a campaign stage in Ahrensburg, a town in the northern state of Schleswig-Holstein, and said: "There will have to be another (bailout) program in Greece."
So there it was. At first, Schäuble's aides tried to dismiss the treacherous sentence as a regrettable slip of the tongue, but by then the debate could no longer be stopped. "So there will be more money for the Greeks, after all," the tabloid Bild wrote in a front page story. Former Chancellor Gerhard Schröder accused the chancellor of having told "a very big lie," and campaigners for the euroskeptic Alternative for Germany (AfD) party were delighted at this unexpected boost to their campaign. Greece, said party chairman Bernd Lucke, "should withdraw from the euro."
Many in the CDU and its junior partner, the pro-business Free Democratic Party (FDP), were unhappy about Schäuble's remarks. They accused him of seeking to portray himself as a straight-talking politician, at the expense of the chancellor. And Merkel herself, after a day of speechlessness, gritted her teeth and conceded that her finance minister was right. But she noted that it was still unclear how large the new Greece package would be.
Another Red Line Crossed
Once again, the chancellor was forced to place herself in the unpopular role she has assumed so often in the course of the euro crisis: as a master of crossing red lines. First she said Germany would not be sending a cent of aid to Greece. Then she assured Germans that Europe's bailout funds would only be temporary. Finally, she denied that Greece's first bailout package would soon be followed by a second one. Each time, she was forced to break her promises, and each time the amount of money the Germans are committing to support the euro became larger. By now, German taxpayers are guaranteeing loans worth a total of 122 billion ($163 billion).
For weeks, the CDU/FDP coalition had managed to keep the monstrous numbers involved in the euro rescue out of the campaign. A series of favorable economic figures from Southern Europe even raised hopes that the crisis could soon be over. The message from the government in Berlin was that everything necessary had been done and that the worst was over.
But there is a different reality, as Schäuble's admission reveals: Although the politicians involved in saving the euro have treated a few symptoms of the disease, the patient is by no means cured, and more treatments are necessary. Despite green shoots of economic recovery, the mountain of debt in Spain and Ireland continues to grow, Europe's banks still have large quantities of bad loans on their balance sheets, and if the euro is to be rescued, the Germans will have to relinquish additional political powers to Brussels. The truth is that after the election, the Germans will be presented with even more bills for saving the euro.
'There Will Be No Debt Haircut'
But the German government wants none of it at the moment. When it comes to restructuring European bankers, Berlin still gives the impression that the costs could simply be passed on to the government budgets of crisis-hit countries. And even on the issue of Greece, the government is once again making promises that it probably won't be able to keep. In an interview with the business newspaper Handelsblatt last week, Schäuble said that the repayment periods of loans to Greece could be extended and the interest rates on them reduced. But he ruled out the possibility of Germany directly waiving a portion of its claims. "There will be no debt haircut," he stressed.
It is clear, however, that Greece will not get back on its feet without new aid. The country currently doesn't stand a chance of returning to the capital markets to borrow money on its own by the end of next year. Greece's national debt has now reaching a dizzying 160 percent of its gross domestic product (GDP). Under the bailout programs, this number is expected to decline to 120 percent in the next seven years. European leaders hope that a debt-to-GDP ratio of this magnitude is sufficient to enable a country to return to the capital markets and obtain its own financing once again. But no one seriously believes that Greece can reach this level without further assistance.
That's why the International Monetary Fund (IMF) has long called upon Greece's creditors to agree to another debt haircut. The Bundesbank also believes that new bailout programs will become unavoidable soon after Germany's general election on Sept. 22.
In Brussels, the European Commission assumes that the Greek bailout is proceeding in small steps, each at a cost of billions. "The subject of Greece reappears on the agenda every six months," says a Commission member. This makes sense, because it ensures that the Greek government remains under pressure to enact reforms.
For Eurocrats, the notion of substantial additional funds flowing from Brussels to Greece is absurd. Even today, for investments from the structural fund, for example, the Athens government contributes only five percent of the funding itself, whereas other countries must come up with 25 to 50 percent of total funding. For this reason, the experts in Brussels are desperately searching for Greek infrastructure projects that make at least some sense.
In September, the troika will pay Athens another visit to assess the country's reform progress. The government has managed to push spending below revenues and is likely to be rewarded with a new aid package, to be approved this fall. The interest rates on the current loans, which are now averaging 2.3 percent, according to IMF calculations, are to be pushed down even further toward zero. But the troika also wants to see the loan repayment dates postponed for as long as possible. Both measures would reduce the country's annual debt burden.
Under a similar plan being discussed in Berlin, loans with a duration of up to 30 years could be extended to 50 years. At the same time, the creditor nations could largely waive their interest claims.
The beauty of the German solution is that it would not be a debt haircut. The creditors, including Germany's state-owned KfW development bank, as well as the European bailout funds, would not have to write off portions of their loans. Instead, the loans would remain on the books until the end of the extended term.
But the costs for the donor countries would remain substantial. Germany would be faced with costs in the double-digit billions, and Greece would still not be recapitalized. EU officials believe Greece will need a real debt haircut in less than a year, and government experts in Berlin agree with them.
Even with sustained budget surpluses, Greece will never escape from the debt trap it has gotten itself into. Sovereign creditors like KfW would have to write off at least a portion of their claims. The European Central Bank (ECB), also one of Greece's creditors, would likely be left out of a debt haircut. If the ECB waived its claims against the Greek government, it would be tantamount to the direct funding of a government, which the central bank is barred from doing.
Ireland, Portugal Also Likely to Need More Help
Ireland, which has so far been lauded as a paragon among ailing EU nations in the debt crisis, is also likely to need more help. The truth will become apparent in October, shortly after the German election. Ireland will have to give up its pretense that it won't need any more help once the bailout package expires.
The 67.5 billion bailout program for the Irish runs out at the end of this year, at which point Dublin will have to start borrowing from banks and private investors again. But as leading Irish politicians see it, that will only be possible if the Europeans provide a generous loan guarantee to fund the Irish government. In mid-July, Irish Finance Minister Michael Noonan presented his counterparts in the euro zone with his country's wish list. "What I would like to see is a backstop arrangement which would give additional confidence to the market," he said afterwards. In other words, Noonan wants the European Stability Mechanism (ESM) to provide his country with an unlimited line of credit, which he can access when the capital markets begin to question Ireland's creditworthiness.
At the current 125 percent debt-to-GDP ratio, such doubts can easily arise. Irish interest rates have fallen sharply because banks and investors assume that the Europeans will not abandon the Irish. But the government still spends more than it takes in. In addition, the volume of bad loans on the balance sheets of Irish banks is still growing. Experts estimate that the banks will need several billion euros in additional capital.
With a new aid request in October, Dublin plans to qualify for the ECB's support program, which calls for the unlimited purchase of sovereign debt if necessary. It's ECB President Mario Draghi's Big Bazooka, with which he has kept the markets at bay until now.
So far Portugal, which will probably need new aid from Brussels too, has also relied on the weapons of the monetary watchdogs. This became clear in July, when the yields on 10-year government bonds climbed above 7 percent. The resignation of the Portuguese finance minister had triggered a government crisis. Investors feared that the country would no longer keep its reform promises.
The 78.5 billion in aid commitments the IMF and the Europeans made to Portugal will last until June 2014. After that, Western Europe's poorest country is expected to be able to finance its national debt of more than 200 billion on the capital markets again. Whether it will succeed without the Europeans providing the country with another bailout is more than doubtful. For this reason, officials in Brussels are considering a "preventive credit line" for Portugal within the ESM, which would be used in a worst-case scenario.
Portugal's economic and political crisis has eased somewhat. The conservative government under Prime Minister Pedro Passos Coelho survived a no confidence vote and remains in power. For the first time in two-and-a-half years, the economy showed growth over a quarter, tourism was on the rise and even exports were up again.
But the government deficit also continued to grow, most recently to 127 percent of GDP. As with Greece, Portugal's international creditors believe that the country should be able to repay its debts at debt-to-GDP levels of 120 percent or less.
So far the Portuguese, despite painful austerity measures, have missed every deficit target that the Europeans and the IMF imposed more than two years ago. Now the government wants to ask for mercy from the troika, which will resume its inspections in Lisbon soon. The country is in fact expected to save another 4.7 billion if it hopes reach the goal of new borrowing amounting to 5.5 percent of GDP.
Cyprus Needs More Help To Avoid Bankruptcy
The situation is also tense in Cyprus. It is all but certain that the country will not be able to avoid a government bankruptcy with the current aid package. According to recent calculations, Nicosia will need a total of 23 billion by 2016, a gap Cyprus will be unable to close by itself. President Nikos Anastasiadis wants the austerity demands on his country be relaxed. According to Anastasiadis, they are stifling the Cypriot economy, because they impose an excessive burden on the Bank of Cyprus, the country's largest financial institution. The economy is running out of money.
Although European leaders had assumed that the Cypriot economy would shrink by 8.7 percent, the recession is likely to be even more severe. Without new aid, the island republic would slip into a national bankruptcy, because the country is unable to cut costs any further. The troika experts will travel to Nicosia in September, and then return to Brussels to present their results.
At first, European leaders had hoped that Southern Europe's crisis-ridden countries would make do with a one-time financial injection from the new bailout funds. But those hopes have now been dashed. In fact, bailout programs threaten to become the norm. A large part of the Mediterranean region will soon be requesting new aid, while the creditor countries of the north will try to fend off the requests.
In this way, European leaders want to ensure that banks in the euro zone will resume lending money to companies and property developers at affordable interest rates. But the German government has been blocking this important program for months.
- Part 1: Crisis Could Damage Merkel's Campaign
- Part 2: Germany Putting Brakes on Banking Union
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