The Baseline Scenario
What happened to the global economy and what we can do about it
Imminent Eurozone Default: How Likely?
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By Simon Johnson
The big question of the week in Europe is deceptively simple – will any countries that share the euro as their currency default on their government or bank debts in the foreseeable future? The answer to this question determines how you regard bonds from countries such as Portugal, Spain, Italy, and Belgium.
Answering this question is not as simple as it seems, however, because it involves taking a view on three intricate issues: What exactly is the eurozone policy now on bailouts, can big eurozone countries really be bailed out if needed, and what happens to the politics of these countries and of the eurozone has a whole as pressure from the financial markets mounts?
The prevailing consensus – and definite official spin – is that over the weekend European leaders backed away from the German proposal to impose losses on creditors as a condition of future bailouts, i.e., from 2013. The markets, in this view, should and likely will calm now; there is no immediate prospect of any kind of sovereign default or (more politely) “reprofiling” on debt, including the obligations of big banks.
But a close reading of the Eurogroup ministers’ statement from Sunday suggests quite a different interpretation. It’s a straightforward text, just 2 ½ pages long, but it has potentially momentous consequences – as it envisages dividing future eurozone crises into two kinds.
“For countries considered solvent, on the basis of the debt sustainability analysis conducted by the [European] Commission and the IMF, in liaison with the ECB [European Central Bank], the private sector creditors would be encouraged to maintain their exposure according to international rules and fully in line with the IMF practices. In the unexpected event that a country would appear to be insolvent, the Member State has to negotiate a comprehensive restructuring plan with its private sector creditors, in line with IMF practices with a view to restoring debt sustainability. If debt sustainability can be reached through these measures, the ESM [European Stability Mechanism] may provide liquidity assistance.” (from the middle of p.2; emphasis added).
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