Brussels: Europe on Monday announced a trillion-dollar rescue package for crisis-hit euro countries backed by the IMF and central banks worldwide, sending the euro surging in Asian trade.
Leaders hope an unprecedented international intervention, officially running to more than 750 billion euros, will represent a game-changing financial war chest.
Essentially, Europe wants to leverage vast borrowings to prop up nations the way governments did their banks during the global financial crisis - keeping interest rates down.
The Bank of Japan joined the European Central Bank (ECB) and those of Britain, Canada, Switzerland and the United States in coordinated moves aimed at nudging global money, debt and currency markets forward, which drew ringing endorsements from the Group of 20 leading world economies.
A statement issued by South Korea, which will chair a G20 summit in November following a summit hosted by Canada next month, said members remain "strongly committed" to working together to maintain global financial stability.
European Union finance ministers agreed, after marathon talks lasting more than 11 hours, that 440 billion euros would come from the troubled eurozone plus another 60 billion euros from the European Commission coffers.
That would be backed by "at least half as much" again from the International Monetary Fund, or another 250 billion euros.
The overall package was described as a series of "far-reaching steps" by IMF managing director Dominique Strauss-Kahn.
The plan "proves that we shall defend the euro whatever it takes," said the EU's commissioner for economic and monetary affairs, Olli Rehn.
The battered euro currency surged over the 1.29 level against the dollar in Asian trade, up from 1.2755 dollars in New York late Friday.
Last week, it had hit a 14-month low of 1.2523 dollars last week on fears that marbled European debts could hit the world's financial system in the same way the collapse of Lehman Brothers did two years ago.
Tokyo stocks also rose, and the European Central Bank subsequently said it would "conduct interventions in the euro area public and private debt securities markets."
The ECB said these were justified by "exceptional circumstances," and further announced that it along with central banks in Britain, Canada, Switzerland and the United States would intervene to ensure that dollar shortages do not occur in European markets.
Traders and analysts have been pushing in recent days and weeks for the Frankfurt-based institution to implement a so-called "nuclear" option, seeking its agreement to buy euro countries' bonds or accept toxic eurozone government debt as collateral.
The breakthrough followed urgent telephone calls during Sunday between US President Barack Obama, German Chancellor Angela Merkel and French President Nicolas Sarkozy.
FAQ: What is Greece's crisis?
Q. What is the nature of the crisis Greece is facing? Why is the program needed?
Greece is highly indebted and lost about 25 percent of its competitiveness since Euro adoption. At the end of 2009, the general public deficit reached 13.6 percent of GDP and public debt had increased to 115 percent of GDP. Even with the lower deficits envisaged under the program, the debt as share of GDP will continue to peak at almost 150 percent of GDP in 2013 before declining thereafter.
In past years, Greece's public sector spending grew, while revenue fell. Then the global recession hit and economic activity slowed and unemployment rose. This exacerbated the fiscal situation.
Financing costs for Greece rose rapidly, adding to the already high debt burden. To stop these snowballing dynamics, the Greek government realized that a strong economic program was the only viable option.
Q. What are a few of the most important measures in the program?
A significant fiscal adjustment is needed in Greece. The program is designed so that the burden of adjustment is shared across all levels of society, while protecting the most vulnerable groups.
The government's program also includes pro-growth policies to reform such crucial sectors as tax administration, the labor market, the health sector, and the management of public finances.
These measures will open up the economy to opportunity and make the economy more competitive, transparent, and efficient. This in turn will help restore confidence of investors and the markets. The ultimate goal is more dynamic and durable growth.
On fiscal policy, the program has strong measures-many of them front-loaded-to reduce government spending and raise revenue as well as sweeping reforms to modernise the public sector. Fiscal measures of 11 percent of GDP over three years will be added on top of the 5 percent of GDP in measures already taken earlier this year by the authorities, for a total of 16 percent of GDP. The adjustment is designed to get the general government deficit to well below 3 percent of GDP by 2014 (from 13.6 percent in 2009) and begin to lower the debt-to-GDP ratio from 2013 onwards.
The fiscal measures include: a reduction of public sector wages and pensions-something which is unavoidable given that these two elements alone constitute some 75 percent of total (non-interest) public spending in Greece. Growth in entitlements in Greece has been way beyond the Euro zone average and one of the major strains on the budget. Revenues will also be increased (e.g., through an increase in the VAT and some excise taxes and efforts to improve tax collections).
Q. Is the range of conditionality in the Greek program a return to the more traditional IMF “austerity” measures of the past?
No. There are three key differences:
• This program is focused on Greece' two key problems: high debt and a lack of competitiveness. Conditionality is very much focused on these issues.
• The Greek authorities have strong ownership and leadership and it is their program.
• The program includes measures to protect the most vulnerable, which are a critical component to effective implementation.
Q. Would it not be better for Greece to restructure its debt?
We agree with the authorities that a debt restructuring is not in their interest, nor do we think it is in the broader interests of the Euro Area and beyond.
Debt restructuring is not a silver bullet.
• It doesn't help Greece's capacity to grow. The type of fiscal and structural reforms being put in place under the Government's program are designed to do that – to bring down costs, to make the labor market more flexible and to improve the business and investment climate.
• The web of economic and political inter-linkages – including that Greek bonds are held by a wide variety of private investors and public entities – severely complicates alternatives to the program the government has put in place. Any perceived positive near term effects of a debt restructuring need to be weighed against contagion effects.
• Most of the adjustment in Greece is needed to eliminate its large primary deficit (the deficit net of interest payments). This is the main issue for Greece, not the level of the debt.
Prudent debt management is part of the government' program. The Greek government is updating its debt management strategy and its tools to ensure that risk is adequately managed, and the scope for coordinated voluntary rollover understandings among creditor groups will be explored.
Q. What is being done to raise revenues?
Additional specified tax measures amount to about 4 percent of GDP. The government is proposing measures to overhaul the tax system, including a progressive tax scale for all sources of income, taxing luxury goods, higher taxes for the wealthy, and higher taxes on tobacco and alcohol.
The government's actions will build on their current efforts to strengthen revenue administration and reduce tax evasion – which is a significant drain on the government's finances and a source of unfairness in Greek society.
Q. Why does the VAT need to be raised?
While the emphasis in the Government's program is on reducing expenditures to support competitiveness and growth, revenue- raising measures are just as essential to put the fiscal finances on a sound footing. The government has proposed a range of tax measures with the aim of spreading the burden of adjustment more fairly.
The base of the VAT will be broadened and rates increased. This will be complemented by other tax measures, for example in those areas where excise taxes are below the euro area average.
Q. Are the rich going to pay taxes and be taxed more?
Yes. Tax evasion, particularly from high-income groups, is rampant. The government plans to address this with the help of a strong anti-evasion effort and a significant strengthening of tax administration. In addition, revenue-raising measures from the higher income groups will include: an increase in taxation on liberal professions, an increase in the taxation of luxury goods, and a temporary surcharge on highly profitable entities and high valued properties.
The government's overarching aim is to inject more fairness into the tax system.
Q. How much is being asked in budget cuts?
Specified expenditure cuts will yield savings of 5.2 percent of GDP. The government is mainly proposing measures that will bring Greece in line with other, more competitive, economies. The extra two months salaries-the so-called “13th and 14th” payments-are unsustainable and do not exist in many other countries. Nor is the low retirement age that begins around 50 for some groups in line with life expectancy.
Q. Will the program hurt the most vulnerable people?
The government is committed to maintaining fairness in putting its finances on a sustainable path and protecting the most vulnerable from the effects of the downturn.
For example, minimum pensions and family support instruments will not be cut. In addition, the targeting of social expenditures will be revised to strengthen the social safety net for the most vulnerable. The new pension system will include a means-tested pension for all citizens older than the normal retirement age so that an important safety net is provided, consistent with fiscal sustainability.
Q. Why do public salaries need to be cut (and the 13th and 14th month salary payment eliminated)?
Past increases in wages far outstripped increases in productivity and, partly as a result, Greece lost competitiveness. Since adopting the Euro, Greece's competitiveness has declined by 25 percent, hindering growth and necessitating imports to be financed through external debt. In addition to the wage freeze, the elimination of the extra salary payments for the public sector will help moderate and reduce wage costs for the economy as a whole and make Greece more competitive.
The authorities recognize that the public sector in Greece has become too large and costly for the economy. In fact, there is no clear data on exactly how many people are working in the public sector. The government aims to reduce its size, make it more agile, and orient it to providing better services.
Q. Why is the retirement age being raised?
The pensionable retirement age for some groups beginning at around 50 is out of line with life expectancy in Greece-and out of line with the rest of the Euro zone countries. Given the aging of the population, such a low age for pensions, coupled with generous coverage ratios to last earned income, has put far too much strain on Greece's public finances.
Projections of future growth in entitlement costs, such as social security under current existing rules, in Greece are among the highest in the EU. There are large overruns consistently in the budget, undermining the viability of the overall social security fund.
Q. With those reductions, why do wages and pension also need to be frozen?
Greece faces a dual challenge. It has a severe fiscal problem with deficits and public debt that are too high; and it has a competitiveness problem. Both need to be addressed for Greece to be placed on a path of recovery and growth.
First, the government's finances need to be sustainable. That requires reducing the fiscal deficit and placing the debt-to-GDP ratio on a downward trajectory. Since wages and social benefits constitute 75 percent of total government expenditure, this means that the public wage and pension bills have to be reduced. There is hardly any other room for maneuver in terms of fiscal consolidation.
Second, the economy needs to be more competitive. This means pro-growth policies and reforms to modernize the economy and open up opportunities for all. It also means that inflation be reduced below the euro area average, including by keeping wages and labor costs flat, so that Greece can regain price competitiveness.
Q. With lower revenue and a stagnating economy, how will Greece begin to grow again?
The government's program recognizes, and takes into consideration, that the difficult fiscal adjustment will initially have a negative effect on growth.
But with effective implementation of the fiscal and structural policies and the support of the Greek people, the economy will be far better placed to generate higher growth and employment than in the past.
Q. What will be the effect on unemployment?
Because of the crisis, employment is already high at about 10-11 percent. Initially, there will be an increase in unemployment and the next two years will be difficult – unemployment could rise to about 15 percent. However, as strong medium-term fiscal measures and productivity-boosting reforms kick in, the economy will become more competitive, transparent, and efficient. With confidence returning, Greece will emerge from this experience in better shape than before, growth will return and employment will pick-up.
Q. Is the banking sector stable?
The current capitalization of the Greek banking system is saatisfactory. It is a traditional banking system that was not exposed to the toxic products that had threatened some other banking systems.
The authorities' objective under their program is to ensure that banks remain adequately capitalized and have adequate access to liquidity, including to emergency facilities. The new Financial Stability Fund – with capital of €10 billion – established under the program will help ensure a sound level of bank equity even under unfavorable circumstances. The extension of the government's existing support facilities and the ECB's decision to ease access to refinancing should also alleviate concerns about financing.
Q. Can this very ambitious program work?
The government is determined to implement an unprecedented program in terms of the adjustment effort-and the international community is providing resources in support of this program on an unprecedented scale.
The Government has already demonstrated its strong commitment to take tough, but needed measures-they had already begun this effort in 2010. In addition, it has front-loaded further strong measures this year. And it has already identified additional measures for the next two years and beyond. There is a clear recognition that this is going to be a multi-year effort.
The measures are tough, but fair and feasible. And the alternative would be much worse for the Greek people who are already caught in a low-growth/high unemployment cycle.
It should be noted that the Greek Parliament has approved the program.
Q. Has any country undertaken this level of fiscal adjustment before?
It is an unprecedented adjustment, but it is feasible, and the government is committed to getting the job done.
The fiscal adjustment is front-loaded. In 2010, the government is adding immediate measures with a full-year impact of 3.75 percent of GDP (or 2.5 percent of GDP in the remainder of 2010), on top of the 5 percent of GDP already undertaken. And it has already identified the remainder of the measures to be taken over the remaining years of the program.
Q. How much money is being provided to Greece to support the program? How is it divided between the EC and the IMF?
The Euro area countries are providing €80 billion and the IMF is providing €30 billion-for a total of €110 billion (about $145 billion). And this is over a three-year period. Each individual disbursement of the loan will be done according to the same fixed proportion of the Euro area countries and IMF's contributions.
This front-loaded program makes SDR 4.8 billion (about €5.5 billion) immediately available to Greece from the IMF as part of joint financing with the European Union, for a combined €20.0 billion in immediate financial support. In 2010, total IMF financing will amount to about €10 billion and will be partnered with about €30.0 billion committed by the EU.
Q. Is this the largest single loan ever given by the IMF? Is it the highest level of access?
At SDR 26.4 billion, the program for Greece entails the largest non precautionary access to IMF resources. Only Mexico's FCL (SDR 31.5 billion) and Brazil's 2003 SBA (SDR27.4 billion) were larger in absolute terms, but both of these were precautionary as these members did not intend to make any drawings.
In relation to quota, Greece's program is also the largest on record at just over 3200 percent of its quota in the Fund of SDR 823 million. Previously, the highest access in terms of quota was Korea in 1997 for its stand-by arrangement (1938 percent of its quota).
Q. How will implementation be monitored?
The program was developed by the authorities with European Commission, ECB and IMF. The IMF, with the European Commission, will review progress under the program on a quarterly basis. The IMF will have to be satisfied that the conditions under the program are met in order to proceed with future disbursements.
Q. Which countries will provide the most resources for the Greek loan? What is the U.S. contribution?
The Fund does not disclose parties on individual transactions, but over time aims to provide a balanced position for all members as reflected in Figure 2 of the published Financial Transaction Plan (FTP).
The FTP is published with a three-month lag (after the end of each plan period); the latest covering the period through end-January 2010 available at: http://www.imf.org/cgi-shl/create_x.pl?ftp
In a transaction of the size of Greece financial support and involving a large number of parties, currency preferences are one of many considerations.
Q. Which countries will bear the main risk of lending to Greece?
The Fund's membership as a whole bears any risk from lending to Greece, but, in its entire history, no member of the Fund has experienced a loss from providing resources to the Fund, either by lending to the Fund or through the payment of quota subscriptions.
Member countries that provide financial resources have a claim on the Fund's balance sheet as a whole. They are not making a loan to the specific countries receiving financial assistance from the Fund.Moreover, the Fund has never suffered a loss on credit outstanding to a member, because it has comprehensive measures to mitigate credit risk, where the economic policies of borrowing members are the most important safeguard.
The Fund also accumulates reserves that would be used to protect the value of member countries' claims on the Fund if there was a credit loss despite these safeguards which have avoided any credit losses in the past.
Q. Will borrowed resources from bilateral loans provided to the Fund be used to contribute to financing the IMF loan to Greece?
Disbursements to Greece will be financed in the same manner as other disbursements, using a mix of quota and borrowed resources, which the Executive Board has set at 1:1 currently.
No specific countries have been selected to provide financing, they will be selected at the time in a manner that aims at balanced burden sharing across the Fund's members over time, which is the approach used for all the Fund's nonconcessional lending.
Q. Will the existing or the expanded NAB be used for the Greece loan?
The Fund's current lending capacity of about $255 billion--from quotas and bilateral loan and note purchase agreements--is adequate to meet the commitment to Greece. So there are no plans to activate the existing NAB, while the activation of the expanded NAB will only be feasible once participants have taken the steps needed to make it effective, which they are encouraged to do in a timely manner.
Q. What interest rate will Greece pay on its IMF loan?
It will be around 3⅓ percent. The specific terms and calculations are covered in the SBA Factsheet, attached and available on the public website here: http://www.imf.org/external/np/exr/facts/sba.htm
Q. What will repayment terms be? How will repayments be structured?
As outlined in the SBA Factsheet, repayments of borrowed resources under the SBA are due within 3¼-5 years of disbursement, which means each disbursement is repaid in eight equal quarterly installments beginning 3¼ years after the date of each disbursement.
