Avoids recession and economic chaos

Relief coupled with apprehension were the emotions that dominated on Thursday following the Euro-zone agreement reached after tough negotiations that lasted into the early hours of the morning. Markets reacted favourably registering a rise of up to five per cent and stocks of French and German banks (which hold a major part of the Greek sovereign debt) rose spectacularly. Greek Prime Minister Georges Papandreou described the agreement as “historic” saying it “opened a new era” of cooperation in Europe.

Leaders of the 17 Euro-zone nations agreed on a three pronged approach to solving the Euro crisis: wipe off 50 per cent of the Greek debt, recapitalise European banks and strengthen the European Financial Stability Facility (EFSF) to leverage up to a trillion Euros in order to prevent Italy or Spain from collapsing.

Last resort

Described as the summit of last resort, this was an occasion where European leaders just could not afford to fail, for failure would result in recession and economic chaos, not just across the Old Continent but around the world. Euro-zone leaders argued bitterly and defended their respective positions to finally reach a compromise at three a.m. in Brussels on Thursday.

The person who emerged as the undisputed and triumphant leader from these negotiations was German Chancellor Angela Merkel whose proposals were earlier endorsed by her country's Parliament, the Bundestag. “I think we rose to the occasion and met expectations, doing what was necessary for the Euro. Such an agreement did not seem possible a few days ago,” Ms. Merkel said. She has been hailed by the German press as the outright winner of these negotiations, “because she managed to impose Germany's vision on Europe, underlining the need for austerity and better economic management while showing solidarity towards the weakest members of European club,” to quote a leading German newspaper.

French President Nicolas Sarkozy, too, could go home happy although he failed to persuade the Germans to allow the EFSF to function as a bank and an extension of the European Central Bank in order to guarantee sovereign debt. This was firmly opposed by Ms. Merkel who carried the day. However, Mr Sarkozy, who is fighting a tough re-election battle next spring and who desperately needed to notch up a few successes can now preside over the G-20 Summit in Cannes with his head held high.

The key point of discord which the Euro-zone leaders had to overcome was the resistance by banks to wipe of 50 per cent of the Greek debt. Under the accord, banks will now wipe of €100 billion from a sovereign debt of €350 billion, reducing it from 160 per cent of GDP to 120 per cent by 2020. Athens will receive a fresh injection of 100 billion Euros by 2014 in the form of loans from Europe and the International Monetary Fund (IMF).

This will effectively replace the earlier pledge of €109 billion decided in July 2011 whereby banks had agreed to wipe off 21 per cent of Greece's debt. As this will result in huge losses for the banks, (Commerzbank, Germany's second largest, alone stands to lose over €700 million), both Ms. Merkel and Mr. Sarkozy had to indulge in some severe arm twisting with bankers. Banks will have to raise €106 billion by June next year.

As part of the plan to increase the clout of the bailout fund, the €440-billion ($610 billion) European Financial Stability Facility will be used to insure some of the potential losses on the debt of shaky Euro-zone countries like Italy and Spain, allowing it to leverage around €1 trillion.

China is expected to buy up European sovereign debt and the Euro-zone President Herman Van Rompuy is expected to fly to Beijing in the next two days. Mr. Sarkozy also had conversations with Chinese leaders on Thursday. It is in China's interest to have a healthy and viable European single currency and market since a large part of China's exports go to Europe.

“But this is not the end of the story. The markets are euphoric because an agreement has been reached. There are still several grey areas such as how the banks will be recapitalised and the exact mechanism for increasing the leverage of the EFSF. I expect markets to turn jittery again next week,” warned Francois Langlais, the director of a major business TV channel, BFM.

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