The Eurozone Deal.

Resisting the temptation to use the issue as a weapon at the upcoming G20 Summit Eurozone leaders yesterday (27/10/11) unveiled plans to finally end the Greek debt crisis without triggering a second credit crunch. From an economic perspective there are three main elements to the plan;

1. A Greek Debt Write Off. Eurozone leaders have agreed that Greece is an exceptional case and that requires extra-ordinary measures to address. Therefore they have given the Greek government permission to default on 50% of it's debts to lenders e.g. banks. In order to soften the blow Eurozone nations will spend E30bn buying up part of the debt that is to be defaulted on. They will also spend E70bn to stabilise Greek banks that are going to be especially hard hit by the default. Although this plan is voluntary and the Greek government will still need to reach agreement with all of it's creditors those creditors have been involved in the process and at the moment it seems that they will agree with the plan.

2. Bank Recapitalisation. In order to allow them to cope with a Greek default or the collapse of other banks European banks will increase their capital reserves to 9%. Although they will be allowed to change the way that debt and equity are recorded on their balance sheets the expectation is that the banks will raise this money from the private sector. If they are unable to do so they will then be allowed to approach the central bank in their home nation e.g. the Bank of England for short term funding. If the Home Central Bank (HCB) is unable to provide those funds the bank will then be able to approach the European Central Bank and the assumption is that the HCB will then have to approach the European Financial Stability Fund (EFSF) in order to avoid collapse.

3. The European Financial Stability Fund (EFSF). The size of the EFSF is to be greatly increased. Part of this extra funding will take the form of Special Purpose Vehicles. These are financial instruments that mean that rather then having all the money dispersed from a central fund donors can team up with recipients and the EFSF in order to target money to specific projects. The idea is to speed up the process by circumventing often convoluted European Union (EU) politics and increase the effectiveness of the spending. The EFSF will also provide bond insurance that will underwrite bond holders against debt default but only if they choose to purchase the insurance and keep paying the premiums. Provided there are no further defaults this could actually help fund the EFSF.

The Eurozone leaders have yet to put an exact figure on how much the EFSF will be increased by. However rather then being due to an inability to agree a figure this is due to an inability to know what that figure will be. For example it's estimated that the funds will have a leveraging effect of up to four of five but could be much lower. Also the plan expects the Greek government to bring it's debts down to 120% of GDP by 2020 through the current package of austerity measures and expects the Italian government to bring it's debts down to 113% of GDP by 2014 by cutting red tape, abolishing internal tariffs and raising the state retirement age to 67. Either of those governments could fail to introduce those austerity measures and even if they did they still might not have the desired effect. Furthermore the Eurozone leaders intend to reach out to China and Brazil in order to get them to contribute to the EFSF. It is rude to be seen to be demanding a specific figure before those negotiations have even begun and could be potentially very embarrassing for the Eurozone leaders if those negotiations fail and they have to increase their own contributions.

The most important element of the deal though is political. Up until now decisions about the Euro have been discussed and made by all 27 members of the EU. From now on though the will only be made by the 17 members who actually use the Euro - the so called Eurogroup. They will hold twice yearly meetings and elect their own president who will periodically inform the other 10 members of the EU of their decisions. This will allow the Eurogroup to work more closely to better co-ordinate their economic policies and will speed up the decision making process by excluding members like Britain who seem to have a problematic attitude towards the single currency.