The most recent “comprehensive package” for the Euro lasted all of four days as the Greek Prime Minister George Papandreou announced plans to put the bailout package to a referendum on the 31st of October. Three days later, he was forced to backtrack on this initiative under pressure from both the European leadership and the opposition in his own country. The decision by Papandreou on the referendum took everyone by surprise and while he was roundly criticised for it, we view this move towards a referendum as a positive step and one that should be quickly implemented in Italy, Spain, Portugal and Ireland. While it may create uncertainty in the short term, it does push Europeto a resolution, and forces all parties to take the tough decisions which have to date been avoided.
Both Greeceand the European powers are still convinced that they can manoeuvre themselves out of Greece’s current debt situation, but in reality there are only simple but tough choices which exist. Current polls show that 60% of Greeks reject the summit deal, and 70% of them want to remain in the Euro. Unfortunately those numbers don’t add up. Greece can either accept the bailout and implement the austerity measures that come with it, or negotiate their exit from the Euro.
While the European powers are panicked at the thought of Greeceexiting the Euro, the bailout packages they have put forward have always left Greecewith unsustainable levels of debt. The latest offer was painted as generous, but even under highly optimistic scenarios it leaves Greece with debt of 120% of GDP. In essence then, as in the case of Greece, the Euro powers can either choose to subsidise the weak economies or they can negotiate their exit from the Euro.
While these decisions are obviously difficult, postponing them is no longer feasible and risks further damage to an already poor economic outlook. Papandreou has been cast as a pariah for bringing up the possibility of a referendum but with virulent opposition to austerity in Greeceit is difficult to see if he has any other choice. The power of the referendum is the fact that it gives the government the mandate to fully implement the required reforms should the Greeks vote to remain in the Euro; essentially it amounts to a buy-in from the Greek people themselves. It also gives lenders certainty that there is a will to repay borrowed money, and not just repudiate the debts later when it is politically convenient. In turn, should Greecechoose to leave the Euro, a well defined exit mechanism for the common monetary area can ensure that this is done in an orderly fashion. While Greece’s debt levels are beyond reprieve, Italycan still be saved and should arguably also move quickly to a referendum: Rising Italian bond yields risks making their debt service costs unsustainable too, and the political impasse means that economic reforms have stalled.
While the market has been pricing in a Greek default since the middle of last year, the European leadership has been too slow to react. They have continued to be in denial as to the extent of the debt problem, while attempting to buy time with ineffectual bailout packages. Time has run out, and the difficult decisions have to be made now. Giving the people the decision through the referendum process and forcing them to live with the outcomes is the only credible step to a full resolution of the crisis.