In the run-up to last week’s European Council meeting (25-26 March), Angela Merkel, Germany’s chancellor, played a blinder. And not just for Germany, for Europe too. But that does not mean that either Greece’s (or the European Union’s) sovereign debt emergency is over. A Greek bail-out this year is still on the cards because, as Erik Nielsen of investment bank Goldman Sachs puts it: “Greece suffers from serious debt sustainability issues resembling a sovereign solvency crisis.”

Some markers have, however, been put down that may help Greece. They also put increased pressure on Spain, Italy and other excess borrowers in the EU, reinforcing the stark warnings coming from financial markets that those countries also have to make more serious efforts to get their budget deficits and debt ratios under control or face publicly humiliating consequences.

The precedent-setting nature of last week’s summit decisions are very important. Global interest rates, both short- and long-term, are still at crisis- management levels. Assuming there is no ‘double-dip’ transatlantic recession, rates will have to rise significantly before too long.

In a recovering world economy that is already being swamped by government borrowers, investors will demand significantly higher returns for the money they are being asked to lend to recidivist debtors. The costs to governments of servicing their borrowings will increase accordingly.

‘Rosy scenario’ budget forecasts, such as those presented by Alistair Darling, the UK’s finance minister, last week (24 March), risk being blown away in a storm of financial speculation.

That, and the evidence from Latin America in the 1980s and Asia in the late 1990s, about how swiftly debt crises can sweep contagiously across borders, is why Germany has been right to take a hard line.

Saving the single currency

What Germany – and Europe – needed most from last week’s summit was a credible political agreement to demonstrate that they could put the bickering to one side and agree on a strategy for managing the crisis in order to save the single currency.

The deal that was struck – essentially between Germany and France – is that if (or, more likely, when) emergency funding is needed by Greece (or any other eurozone country in which financial markets lose confidence), then the money and crisis-management skills of eurozone countries, the EU institutions and the International Monetary Fund (IMF) will be called upon; that the EU, in the shape of the European Commission and the European Central Bank (ECB), will decide when emergency funding is needed; and, crucially, that any single eurozone country will have the power to veto any bail-out proposal.

These terms met France’s insistence that Europe’s destiny should remain in Europe’s hands, not under the control of the executive board of the IMF. But, with its veto, Germany can be assured that it will not be required to swallow some tasteless political fudge cooked up in the backrooms of Brussels, Paris and Washington.

The IMF/EU/Eurogroup co-operation envisaged is intriguing. When the United States and the IMF jointly bailed out Mexico in 1994-95, the US Treasury and the IMF exerted dual conditionality on the terms of the operation. According to one American participant in the negotiations, the US terms for the bail-out were tougher than the IMF’s.

A similar course is possible with the rescue plan for Greece. The Eurogroup veto would give European countries effective control of the conditions attached to any loan. This addresses the fears of Germany (and the ECB) that bringing the IMF in as a partner might give a eurozone borrower an easier ride.

But doubts remain about many other aspects of the summit accord.

Speculation suggests that the scale of the potential official lending being discussed is around €20 billion, but some sovereign debt experts put the figure much higher. Nouriel Roubini, a professor at New York University’s Stern School, says that Greece’s economic reforms need to be backed by “a large IMF programme of €50bn to prevent a run on public debt and banks in the tough times ahead”.

‘Bail-in’ talks

What we do not know is whether there are also so-called ‘bail-in’ discussions going on – namely, pressure on banks (in Germany and France in particular) to roll over existing Greek debts. If so, that would ease market tensions and perhaps mean that official lenders need put less into the pot.

The co-operative EU/IMF bail-out model that has been functioning in eastern Europe for the past two years, known as the Vienna Initiative, is specifically structured to try to keep bank lending flowing both within and across national borders.

Given this background, it is hard to imagine that Nicolas Sarkozy, France’s president, and Merkel have not been having quiet words with their big banks along the lines of “roll over your multi-billion euro lending commitments to Greece or risk an immediate loan restructuring and so-called haircuts [write-downs] of loan values”.

Perhaps the most startling features of the eurozone governments’ communiqué on Greece were the calls for the European Council to “improve the economic governance” (intriguingly, “gouvernement” in the French version) of the European Union; for the beefing up of the stability and growth pact’s excessive deficit procedure; and the creation of a task-force to look at how the Council could create a “crisis resolution” process.

Are these ideas just paying lip-service to long-standing French ambitions to increase fiscal/monetary policy co-ordination in the EU/eurozone – which according to some critics is tantamount to undermining the independence of the ECB?

Do they point to a serious attempt to examine the concept of a European Monetary Fund, along the lines proposed by Wolfgang Schäuble, Germany’s finance minister, last month, and by Daniel Gros and Thomas Mayer of the Centre for European Policy Studies earlier in the year?

Or is this an episode of crisis-induced mania? Sceptics such as Nielsen say that the implied fiscal federalism cannot take place. “You must not be fooled by all this. There is no political union in Europe and there won’t be any,” he says. He may be right. But, all the same, the emerging combination of macro- and micro-prudential financial market regulation and more intense economic policy co-operation that is emerging from the economic wreckage of the past two years is changing Europe’s economic governance.

Stewart Fleming is a freelance journalist based in London.

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