The European Union has approved another round of bailouts for the Greek government, but it’s looking more like a short-term solution than a long-term fix. Initial market enthusiasm for the deal turned to uncertainty as details about the plan were given time to sink in.
News that the plan, reached in Brussels on July 21, won’t include a bank tax, initially prompted a surge in European bank stocks. But sentiment about the bailout cooled quickly, sending European stocks on a slide.
There is significant apprehension about the plan because it will allow Greece to default on part of its debt, despite extending new credit to the sovereign. The latest round of funding includes 109 billion euros in new aid from the E.U., ECB and IMF, with a 3.5% interest rate, a 10-year repayment grace period and a 30 year maturity.
Although the bailout won’t require a bank tax, banks are still going to take a significant hit. Banks holding Greek sovereign debt are likely to take losses of up to 21% on Greek bonds.
This latest bailout is unlikely to be the last, since it doesn’t include enough austerity measures to reverse Greece’s course. Even under conditions imposed on Greece in each of the bailouts, the Greek government is still spending far more than it brings in, so it is difficult to see how this latest bailout is anything other than a temporary measure staving off inevitable collapse.
The bailout package is projected to reduce Greece’s debt to GDP ratio to 140%, which is still far too high. By contrast, the gross U.S. debt to GDP ratio is projected to be in the high 90% range this year—high enough to put the U.S. at 12th highest ratio in the world.
Greek sovereign debt fell further into junk territory as a result of the bailout, meaning it will likely face increased borrowing costs as a result of its default, further hampering its recovery. And default is driving fear of default by other sovereigns. On news that Greece would be allowed to default on part of its debt, bond yields rose for Spain and Italy, making it more expensive for those governments to borrow.
Some E.U. member states are pushing back against this latest bailout. Slovakia’s parliament looks like it may refuse to allow the country to participate in the bailout—it was the only E.U. member that refused to participate in the last round of Greek bailouts.
Despite resistance in Congress, the U.S. has agreed to participate in this latest Greek loan on fear that a Greek collapse will spread across the world economy. The U.S. is the largest shareholder in the IMF, so Washington’s approval is an important component of bailout.
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