Eurozone agreement may be not be enough for Greece

Greece may have gained some breathing space following the decision at the eurozone summit last week for a second rescue package but the risks are still quite high.

Oddly enough, the country may find itself isolated more than ever in the next 12 months or so if pundits who claim the European Union leaders finally succeeded in addressing the systemic nature of the sovereign crisis in the periphery turn out to be right and this poses an even bigger challenge for the country.

By allowing the European Financial Stability Facility (EFSF) to recapitalize eurozone banks, if necessary, buy bonds in the secondary market and offer precautionary credit, the EU has significantly broadened the scope of the facility.

In so doing, the EFSF may be able to prevent other EU countries in the future, namely Spain and Italy, from seeking a bailout like Greece, Ireland and Portugal.

Of course, the EU leaders could have caught the markets even more by surprise if they had agreed to augment the firepower of the EFSF to become more convincing in the eyes of the investment community, but governments in some core European countries have obviously found this to be politically unacceptable at this point.

At the same time, most Greeks appear satisfied by the outcome of the summit since the country will not have to turn to the markets for funding till the middle of 2014. In so doing they are given another chance to put their public finances in order and improve the economy?s competitiveness to regain market confidence by then.

But many appear to forget that this time around things will be even harder for Greece to access the markets because it will bear the stigma of a temporary ?selective? or ?limited? default by some major credit rating agencies since the second aid package involves the participation of the private sector in cost sharing.

The fact that the second rescue package accounts for a relatively small reduction in the Greek public debt means the country will have to convince the markets to finance it with reasonable interest rates even if the size of the public debt remains quite large.

Of course a fast-track privatization program coupled with an expected upward revision in gross domestic product could help, but even so the debt-to-GDP ratio is unlikely to be below 130 percent in late 2014.

Moreover, the government, most political parties and various vested interest groups such as trade unions have so far not shown they have the stomach for the kind of far-reaching reforms needed to control the fiscal crisis.

As a matter of fact, judging from the government?s record, the only measures certain to go into effect will be once again tax increases to be borne mainly by the private sector.

Will this change? We hope so, but realistically speaking we do not see it. To be precise, some of the measures, like tax hikes and some politically easy asset sales, will be implemented but others will run against opposition and bureaucracy.

But the 109 billion euros from the EU and the International Monetary Fund in the second package represent commitments and will be disbursed if Greece honors its commitments as outlined in the so-called midterm fiscal strategy plan.

So the months ahead are likely to see once again a combination of some positive action taken by the Greek authorities and good will expressed by the troika, making the disbursement of the next two or three EFSF-IMF loan tranches possible.

If, however, the package agreed at the EU summit last week succeeds through the EFSF to stop contagion to other EU countries, namely Italy and Spain, the auditors will become gradually tougher in their demands on Greece.

It is noted that Italy?s public debt-to-GDP ratio is estimated at approximately 120 percent, of which almost half is held abroad, while Spain?s debt ratio is estimated at around 68 percent in 2011, of which 42 percent is held abroad.

Italy?s budget deficit is estimated at around 4.2 percent of GDP this year compared to 4.6 percent last year while Spain?s is seen at 6.7 percent of GDP versus 9.2 percent in 2010.

Both countries are barely expected to grow this year, compared to an estimated 3.8 percent contraction of the Greek economy.

Although the Spanish private sector is more leveraged, posing a bigger threat to local banks, the new powers given to the EFSF to recapitalize banks, if needed, may help contain contagion from the fiscal crisis in Greece.

This means both Italy and Spain, which have been the main preoccupation of the EU leadership and perhaps the major reason this important deal was struck last week, have the potential to be out of the woods in the next six to 12 months.

With some encouraging macroeconomic data from Ireland, this is bound to put more pressure on Greece to deliver with its economy likely mired in recession.

What does it all mean? The deal struck by the eurozone leaders may be good for Greece although inadequate as far as public debt reduction is concerned, but looks much better for countries such as Italy and Spain.

In this regard, Greece will certainly have to redouble its efforts to deliver if it does not want to be left out in the cold a year or so from now.