Greek Rescue Spells Tragedy For The Euro

A Greek rescue by the International Monetary Fund, rather than the country’s partners in the European Union, could make traders even more jittery about the euro, analysts and investors said today.

There now seems little chance that a solution to the Greek crisis might emerge from this week’s meeting of leaders from the European Union. Investors now expect little more than a fresh show of moral solidarity for the struggling euro member at the summit on Thursday and Friday.

A concrete plan to offer loans or debt safety nets to the country this week would require a near-miraculous shift in relations, which have been marred by fresh rounds of sniping this week. So despite opposition from senior figures like French President Nicolas Sarkozy and European Central Bank President Jean-Claude Trichet, the IMF could well emerge as the best body to fix Greece’s problems, which are becoming increasingly urgent as its deadline for raising fresh funds in April edges closer.

But the IMF’s famously tough repayment rules could make it more difficult for Greece to stick to its austerity promises and hit future growth even harder. In extreme form, they could even boost the chance that Greece will default on its debts after all–a risk that never fails to rattle the euro.

In sum, this could make an IMF-led solution a bad deal for the 16-country currency.

Lutz Karpowitz, a currencies analyst at German bank Commerzbank in Frankfurt, said:

Whenever European aid for Greece becomes less probable, the euro suffers.

He added that investors are concerned about the IMF’s harsh rules, including clauses that allow it to hold back chunks of loans if recipients fail to make the required savings.

Investors expect the IMF to be stricter with Greece than its European neighbors would be… The likelihood of a default is higher under an IMF program.

Certainly, at this point, a standalone EU solution appears to be a long shot. This week, Greek and German officials have traded increasingly bitter blows over the prospects for European support. Tuesday, Greek Finance Minister George Papaconstantinou said Greece has no need for financial assistance and insisted that the country will fix its fiscal problems on its own. But he also said he still hopes for a “positive outcome” with some kind of stability measures for Greece at this week’s summit. Meanwhile, a German official signaled growing support for an IMF-supported deal.

IMF help isn’t wholly negative. It would be a quick way to bring Greece’s borrowing costs down before its looming refunding deadline, and it offers a tried-and-tested solution from experienced staff.

However, conditions that have been attached to IMF support in the past suggest that Greece would have to make even bigger spending cutbacks than the painful measures to which it is already committed. The idea that this could push Greece into default is extreme, but cutbacks still pose risks.

Hardeep Dogra, a currencies investor at Schroders Investment Management, said:

Even beyond April and May, further down the line, there are very significant risks to growth outlook and a potential for social unrest to escalate. The more extreme the austerity measures, the bigger these risks become. But it’s still not clear-cut; it’s not possible to say at this point whether an IMF program or a European program would be worse for growth and for the euro.

Indeed, the eventual package, if there is one, could be a combination of the two, Dogra added. Whatever the detail in any rescue deal, however, the real damage may come from the blow to Europe’s political clout. Seeking help from the world’s lender of last resort is widely seen as a desperate step that dents a country’s standing for the long term. In this case, the entire euro zone could take that hit as it proves itself unable to deal with internal problems.

Georges Ugeux, chairman of consultancy Galileo Global Advisors in New York, said:

This makes Europe look stupid. Leadership is completely absent. Going to the IMF would be disastrous for Europe. It would lose all credibility.