European leaders meet for a high-profile summit that they hope will produce a clear plan to tackle the sovereign debt crisis that began in Greece and now threatens to drag down Italy, Spain and even France.
The 17 countries that share the euro single currency are working on a deal to bolster the firepower of their rescue fund, called the EFSF, agree a new package of aid for Greece, which will likely involve steeper losses for its bondholders, and unveil a plan to reinforce European banks.
But there is disagreement among leaders on the key issues and Germany, Europe’s largest economy, whose blessing is needed for any plan, has repeatedly played down expectations that the summit will produce a definitive solution to end nearly two years of turmoil in the region’s bond markets, reuters reports.
The political and economic crisis has raised concerns that the euro zone, introduced a decade ago and the crowning achievement of post-war European integration, could be broken up by the departure of one or more member.
Over the past 18 months, euro zone leaders have repeatedly met to try to find solutions to the debt problem, which has its roots in excessive, cheap borrowing over nearly a decade, but have almost always come up short, disappointing financial markets and exacerbating the situation.
Their last attempt was on July 21, when a deal was struck to provide Greece with around 110 billion euros of new aid and have Greece’s private creditors take around a 20-percent loss on their bond holdings. Over the past three months, that deal has unravelled, leading to the need for Sunday’s summit.
The main weapon the euro zone has to fight the crisis is the European Financial Stability Facility, a 440 billion euro (383.8 billion pound) fund that was set up in May last year and has so far been used to help bail out Portugal and Ireland.
Financial markets are not convinced that the EFSF, though sizeable, is big enough to handle problems in Italy and Spain, the euro zone’s third and fourth largest economies.
As a result, there is a plan to try to scale up the size of the EFSF, possibly by using it to provide guarantees to bond market investors, an effort to encourage them to go on buying Italian and Spanish debt and keep them afloat.
Via such a scheme, the EFSF could be “leveraged” by 3-5 times, EU officials say, giving it a headline capacity, once other commitments are factored in, of around 1 trillion euros.
But doubts about the plan are already emerging, with analysts concerned that it could create a two-tier structure in some bond markets, again creating more market uncertainty. As a result, it is far from clear that Sunday’s summit will produce a significant breakthrough on the crisis.
However, leaders may be able to agree on other problem areas, such as the European banking system, where it is estimated that around 100-200 billion euros of new capital is required. And they are expected to decide on ways that they can better coordinate and oversee one another’s economic policies.
A huge concern ahead of the meeting is that failure to agree a plan that convinces financial markets could further chip away at shattered confidence, undermining sentiment towards France, which is worried about losing its triple-A credit rating.
Ratings agency Moody’s warned this week that France’s rating could come under pressure, partly because of exposure to Greece, as well as its deteriorating economic outlook and finances.
If France, the euro zone’s second largest economy, were to lose its top-notch rating, it would undermine the stability of the EFSF, which depends on triple-A guarantees from six euro zone member states to retain its own top rating.
A downgrading of France would transfer extra pressure onto Germany, leaving it as the sole anchor and paymaster for the currency union, a position that would in itself put Germany’s own credit rating under severe strain.