Eurozone crisis: Where things stand

On Tuesday, President Jacob Zuma’s office announced that South Africa will contribute $2-billion (R16.3-billion) to an international fund created to bail out Europe’s debt-stricken nations. The government’s pledge is part of a $75-billion commitment from the Brics nations – Brazil, Russia, India, China and South Africa – to help bolster a $456-billion rescue fund administered by the International Monetary Fund (IMF).

Adding the IMF’s resources to Europe’s own rescue funds, the €500-billion European Stability Mechanism (ESM) and €200-billion European Financial Stability Facility (EFSF) brings the total amount set aside over the past two years to help stabilise the situation in Europe to more than $1.3-trillion.

That is an enormous sum of money, an amount equal to almost three times South Africa’s entire economy. But even this may not be enough to prevent an economic catastrophe.

Four European countries – Greece, Ireland, Portugal and Spain – have already received bailouts from the European Union and IMF totalling more than €500-billion. Spain’s request was specifically targeted to the country’s troubled banking sector, but fears are mounting that the country may soon require a second, general bailout. Italy may need assistance as well and the situation in Greece is far from stable.

US banking giant JP Morgan estimates that Spain has about €350-billion in borrowing needs over the next two years. Italy’s requirements are even larger, €670-billion. Combined, that is over €1-trillion, more than enough to swamp current rescue funds.

The problem for both countries is that fears over their debt, banking systems and economic situations have driven bond yields, representing the cost of borrowing, to unsustainable levels. Unless these yields are brought down, the two countries may find themselves unable to access bond markets, through which government borrowing occurs.

If one or both countries find themselves ‘shut out’ of the market, and are unable to access emergency financing, they could default on their debts. Because banks and other governments hold this debt, such an eventuality would have devastating consequences for the global financial system and economy, including the possible destruction of the eurozone, Europe’s 17-member common currency bloc.

How did we get here?
Europe’s debt problem has been a long time in the making, but the current crisis can be traced back to 2009. In the wake of the global financial crisis that triggered the ‘Great Recession’, deeply indebted Dubai World, a Mideast property developer, found itself in financial trouble.

Investors had assumed that Dubai World’s debts would be backed by government but in November 2009, officials said that they would not assume liability for the developer’s debt. This prompted fears among investors that other government debt was not as safe as previously assumed.

Greece, whose debt totalled €300-billion or 113% of gross domestic product (GDP) – the broadest measure of the size of a country’s economy – quickly found itself in the firing line. By January 2010, concerns spread from Greece to other deeply indebted European countries, including Ireland, Portugal, Spain and Italy.

By May 2010, the situation had deteriorated so badly that Greece was forced into a €110-billion bailout by European leaders and the IMF. In November 2010, Ireland received an €85-billion rescue. Portugal followed with a €78-billion package in May 2011.

Despite these interventions, the situation continued to worsen throughout Southern Europe and, in March of this year, Greece was forced into a second €130-billion bailout that included an agreement with private bondholders to write-down a massive portion of the country’s existing debt. Early this month, Spain requested €100-billion in funds to shore up the country’s fragile banking system.

Because the Spanish government is on the hook for these funds, demand for Spanish bonds continued to fall, driving bond yields (borrowing costs) to record highs. Italy’s were not far behind. Both have since dropped, somewhat, but are still too high for comfort.

What can be done about it?
Since the crisis erupted in 2009, Europe’s policy response has been slow, muddled and – in the mind of many economists and investors – insufficient. Led largely by Germany, the continent’s largest economy, European leaders have combined financial assistance with binding measures to reduce government debt levels, through tax rises, spending cuts and structural reforms.

The problem with this approach, some economists believe, is that these ‘austerity measures’ are withdrawing money from the economy in a time of recession, thus making matters worse. Debt levels are not shrinking, but economies are.

As a result, a growing number of European leaders are calling for a relaxation of austerity rules and implementation of additional measures to stimulate economic growth. To address the debt crisis specifically, some leaders are calling for the establishment of ‘eurobonds’.

These bonds would spread the liability for an individual country’s debt across the eurozone as a whole. Borrowing costs for ‘risky’ countries, like Greece or Spain or Italy, would be brought down if their debt was backed by strong economies such as Germany. The problem is that Germany, and other Northern European nations, are understandably reluctant to put their own credit at risk for the sake of their profligate neighbours to the south.

Until European leaders are able to find some sort of compromise, the global economy will remain in a perilous state. Europe’s leaders will meet next week for another summit on the situation. Markets will be watching their actions closely. Time is running out.

Finance Minister Pravin Gordhan expressed the frustration of many earlier this week: “There’s no doubt the downside risks have been increasing as we see Europe moving from one point of non-resolution of their problems to another point of non-resolution.”