A protester shouts slogans during a rally in Athens against the government's decision to ask for an economic aid package on Friday.YIORGOS KARAHALIS/Reuters
Battered by surging deficits and soaring borrowing costs, Greece appealed for a €45-billion ($60-billion) bailout package from the European Union and the International Monetary Fund to help fix the country's crumbling finances.
On the island of Kastellorizo, far away from the protests and strikes in Athens, Greek Prime Minister George Papandreou said the country has run out of time and the financial wherewithal to continue funding its spending. "It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism we jointly created," he said.
The soothing backdrop of the Aegean Sea may have been designed to send the message that a bailout will fix Greece's problems. While an emergency funding package will buy Greece time, analysts say it remains far short of curing the country's solvency crisis.
"In the longer term, it's just sticking plaster over the situation," Daragh Maher, deputy head of Credit Agricole CIB's foreign-exchange strategy, said in reference to the emergency funding. "The question remains how Greece can extract itself from its problems, and the situation remains highly uncertain."
Greece's budget deficits keep getting revised upward. Debt is ballooning, and the economy lacks growth. Austerity programs are highly unpopular, to the point that Greek cities are routinely paralyzed by strikes and protests.
The upshot is that Greece still faces excruciating economic pain and may eventually have to restructure its debt - leaving bondholders with losses.
Mr. Papandreou's request for the EU-IMF loans came a day after Eurostat, the EU's statistical branch, revealed that Greece's 2009 budget deficit was 13.6 per cent of gross domestic product (GDP), up from the previous estimate of 12.9 per cent. Last year, before the election of Mr. Papandreou's socialist government, the official figure was about half that level. The wider deficit hammered the prices of Greek bonds Thursday, sending the yield on the 10-year notes to about 9 per cent, a level that signals investors are worried about the possibility of default. Moody's capped off a bad day by downgrading Greece's debt.
The confidence crunch made Friday's plea for loans inevitable. The rescue package is an "extreme necessity," the Prime Minister said. "The time that was not granted to us by the markets will be given to us by the support of the euro zone."
The €45-billion package - two-thirds from the EU, the rest from the IMF - should be enough to finance Greece's budget deficit for the rest of the year (total financing needs this year, interest payments included, are €53-billion).
But Greece is in dire financial and economic shape, suggesting the country will need more support than the amount so far on offer. Greece has vowed to get its monstrous deficit down to the 3-per-cent EU limit, but doing so will likely take years. Its funding costs are high because of lack of confidence in its recovery plans. Recently, the country had to pay 4.55 per cent to borrow six-month debt at time when central rates are a mere 1 per cent.
As the deficits continue and as the funding proves expensive, Greece's debt will keep rising. Some economists expect the debt-to-gross domestic product ratio will rise to 150 per cent by 2014, compared with 113 per cent last year. By comparison, Spain's was 54 per cent last year. If the GDP side of the equation were rising, the situation would not be dire. But Greece's economy is stalled and could go into reverse as the austerity programs kick in and the EU recovers more slowly than expected.
The EU bailout "certainly does not mark the end of the crisis. There's still much further to go," said Ben May, European economist at Capital Economics. "They've still got the medium-term problems of getting their public finances in order, and obviously the issue of competitiveness."
Marco Annuziata, economist in London at UniCredit, said widespread talk about the probability of a debt restructuring is "extremely troubling, as there can be an element of self-fulfilling prophecy, as fear of a restructuring inevitably keeps yields at elevated levels."
Typically, debt restructurings involve a reduction in principal, known as a "haircut," a lengthening of debt maturities, possibly with a grace period on principal repayments, or a lower interest rate. Each option comes with risks. Lengthening maturities, for instance, only buy more time because it leaves the debt in place.
Any of the scenarios would be resisted fiercely by the European banks that made the unwise decision of loading up on Greek debt. It is estimated that the banks hold €100-billion or more of Greek securities. If that debt were to be written down, the banks, some of which took bailouts themselves to survive the credit crunch, would be further weakened.
In the meantime, Greece will have to show investors that it is not simply taking the money and running. Economists say the country will have to simultaneously cut spending sharply while developing a strategy to restore growth and competitiveness, neither of which will be easy.
The IMF will almost certainly impose even tougher austerity measures than the ones already set out by the Greek government. Greece could be crippled by strikes and protests, possibly even riots like the ones that made Athens look like a war zone in December, 2008. As Greece continues to struggle, confidence in the euro may not come back quickly.