James Haley is director of the global economy program at the Centre for International Governance Innovation (CIGI)
“Will they, or won’t they?” That was the question that preoccupied global financial markets as investors around the world waited to see if Europe would approve the next installment of a bailout package that would allow Greece to avoid defaulting on its sovereign debt.
The overnight news is that Brussels has approved the package of measures identified by the Greek government. But, before global investors heave a collective sigh of relief, they should pause and reflect. After all, Greece faces a very difficult challenge ahead. Agreeing to measures is one thing; implementing them is an entirely different matter. And, over the past week, attitudes in other European capitals have hardened -- with demands for greater external oversight of Athens’ budget.
What is going on here? Part of the answer is that politicians in creditor countries are responding to taxpayer concerns that their hard-earned money should not be used to bailout their less industrious euro partners. There is something else at work, however. As Gavyn Davies notes in the Financial Times, the proposed bailout package would lead to the socialization of Greek debt as official sector exposure increases, private sector exposure falls, and the overall debt burden is only modestly reduced. Given the prospective increase in public exposure, officials in creditor countries are determined to safeguard public monies.
In the domestic context, the conditions, or covenants, written into bond issues of a firm are designed to limit the extent to which the borrower can shift additional risk to the bondholder. If the firm fails to honour its covenants, or defaults on promised payments, creditors can take it to court. The creditor-debtor relationship is a business transaction enforceable in law.
At the international level, in contrast, bond covenants or the conditionality of bailout packages are often viewed as an infringement on national sovereignty. Countries may agree to them, but do so reluctantly; often under the duress of eleventh-hour negotiations. On this basis, over the past several weeks, we have observed the gradual loss of Greek independence.
It has not gone unnoticed in Greece. To the average Greek citizen, it does not matter that the bailout conditions are being written in Brussels, rather than the financial markets of New York, London or Frankfurt. In fact, it may wound Greek pride more that the conditions now being imposed are dictated by European partners in Berlin and Brussels, rather than the financial gnomes of Zurich or the bond traders of Wall Street for whom it just business. Regrettably, but all too predictably, the result has been an increase in anti-German rhetoric; a rise of nationalism.
In such circumstances, investors understandably not only weigh the sovereign borrower’s ability to repay – the capacity of the economy to generate the revenues required to service the debt – but also the borrower’s willingness to repay. If the costs of meeting their obligations, including the perceived the loss of sovereignty that entails, exceed the benefits from maintaining its access to capital markets, governments may view default as the lessor of two evils. The fact that the proposed bailout socializes the claims on Greece, while doing very little to reduce the overall debt burden, may increase this risk. The political calculus here is depressingly familiar: Confronted with the certainty of a long, painful period of adjustment with little prospect of improvement under the terms of a bailout package dictated by others, or an uncertain, but independent, future free of the constraints imposed by the euro, many would chose the latter.
