Designing credible bailouts

With bureaucratic slowness, the economy ministers of the Eurogroup are beginning to understand the problems posed by the existing procedures for public-debt bailouts of countries in the euro zone. At the meeting that began on Monday they approved the plan for aid to Portugal, which involves a loan of 78 billion euros. Portugal will pay interest of between 4.25 and 5.25 percent on the tranche of the loan facilitated by the IMF (26 billion euros), and between 5.5 and 6.0 percent for the remaining two-thirds contributed from European funds.

The requirements imposed on Lisbon in exchange for the loan aimed at avoiding a default are in line with what was expected: fiscal consolidation, reforms to the labor and housing markets, and the recapitalization of the banking sector.

Analysts insist that the demands are "very mild," but the fact is that they include some requirements which are especially painful for Portugal (such as a drastic privatization program for public sector companies). Above all, these requirements will drive the Portuguese economy into a deep recession for at least the next two years. All the foregoing delineates the same paradox of fiscal adjustment that now grips Greece and will probably soon grip Ireland: the fiscal contractions demanded diminish the possibility of growth and thus reduce the chances of the country that is being bailed out of paying off its debt. The rescue package cul-de-sac has only one way out: a sharp reduction of real salaries, accompanied by cutbacks and reforms.

Brussels is facing the risk that Greece is only a foretaste of what may happen in Ireland and Portugal. The Greek economy, which received 110 billion euros in its 2010 bailout plan, simply cannot pay the debt as it falls due. It needs an additional input of another 60 billion euros. The EU economy ministers put off the solution until June, but at this time it seems likely that the money will be granted, and the loan conditions softened (lower interest rates, longer maturities).

Possibly European commissioner Olli Rehn is right in demanding of Athens more rapid economic reforms, and immediate privatizations; it is also possible that the economists who are calling for a restructuring of Greek debt may be right, too. But the fact is that Berlin and Paris cannot accept a failure of the Greek bailout. It would set a demoralizing precedent: hence they are beginning to take an "understanding" line on an additional rescue plan for Greece.

There is nothing for it but to modify the conditions of the bailouts. This means lowering the cost of the loans, extending maturities on them, and giving more time for the deficit to be reduced. It is hard to believe that Portugal can move from a deficit of 9.1 percent of GDP in 2010 to 3 percent in 2013 with an economy in recession. Adjustment demands must be possible and credible, to avoid failures that would jeopardize the euro. The opinion of Mario Draghi, who will become president of the European Central Bank in October, will be of crucial importance in the debate.