International

Greek Cabinet reshuffle eases euro fears

ATHENS/BERLIN: Greece’s embattled prime minister sacrificed his finance minister Friday to force through an unpopular austerity plan and avert bankruptcy, while EU powers Germany and France promised to go on funding Athens.

After a week of political turmoil and violent protests in Athens, Prime Minister George Papandreou put his main socialist rival into the Finance Ministry in a bid to unite his fractious party behind spending cuts, tax rises and privatizations crucial to securing further IMF/EU assistance.

In Berlin, the leaders of Germany and France, long at odds over how to involve private holders of Greek bonds in a new rescue package for Athens, said they agreed on a mild solution favored by Paris and the European Central Bank.

The outline agreement between Chancellor Angela Merkel and President Nicolas Sarkozy on a second bailout package boosted the euro and reduced risk premiums on Greek and other peripheral eurozone bonds after a weeklong financial rout.

“France and Germany want a new program in place as soon as possible. There is no time to lose,” Sarkozy told a joint news conference with Merkel.

New Greek Finance Minister Evangelos Venizelos, promoted from the Defense Ministry with the extra status of deputy prime minister, said in his first statement to reporters: “The country must be saved and will be saved.”

Analysts said the socialist heavyweight was a second-best choice after Papandreou failed to persuade respected former ECB Vice-President Lucas Papademos to come aboard, but it enabled him to dump several ministers who had obstructed reforms.

Outgoing Finance Minister George Papaconstantinou, who negotiated a first 110 billion euro bailout for Athens last year and had the confidence of international lenders and markets, was moved to the Environment Ministry in a crisis-driven reshuffle.

“Venizelos is politically powerful and that might bode well for the implementation of fiscal consolidation, even though he has no track record in financial matters,” UBS analyst Alexander Kyrtsis said.

Papandreou will seek a parliamentary vote of confidence in the new Cabinet next Tuesday after a debate starting Sunday.

Greek market reaction was positive with bank shares rising nearly 8 percent and the Athens stock market index climbing almost 4 percent.

Bond markets remain spooked by fears of a Greek default and most economists are overwhelmingly sceptical that Greece can ever repay its debt mountain, which has reached 340 billion euros or 150 percent of the country’s annual economic output.

Reuters’ calculations based on five-year credit default swap prices from Markit show an 81 percent probability of Greece eventually defaulting based on a 40 percent recovery rate.

Jim O’Neill, the chairman of Goldman Sachs Asset Management, told Reuters Insider television the risk of a Greek default was “getting closer” and slammed European policymakers for sparring with each other in public. “It is like open theater,” he said.

But Michael Leister, a rate strategist at WestLB, said the common front shown by Merkel and Sarkozy had moved the bloc “a couple steps away from the abyss,” reducing fears of a disorderly default in the near-term.

The ECB and the European Commission have warned that any form of private sector involvement that causes a “credit event” or a downgrading of Greek debt to default status could wreak devastating damage on the eurozone.

They opposed a plan by German Finance Minister Wolfgang Schaeuble for private holders of Greek debt to swap their bonds for new ones with maturities that were seven years longer, giving Greece extra breathing room.

Merkel backed away from that idea Friday, saying she now believed a softer option based on the 2009 Vienna Initiative – a voluntary deal by banks to maintain their exposures in eastern Europe at the height of the financial crisis was a “good foundation” for a deal.

“The quicker we get a solution the better,” she said, brushing aside reports that Berlin wanted to delay a deal until September to try to force a bigger private sector role.

Olli Rehn, the European Commission’s top economic official, said he was confident the next tranche of EU/IMF aid would be released next month and expected eurozone finance ministers to take decisions on a successor program for Greece on July 11.

The announcement by Merkel and Sarkozy caused a sharp reduction of tensions in Europe’s money markets, where banks had shown signs earlier this week of halting loans to each other because of their exposure to Greece.

The one-year euro/dollar currency basis swap spread, which expands when banks become unwilling to supply dollars to each other, narrowed to 25 basis points from 34 bps Thursday, its widest in three months.

Both Merkel and Sarkozy said ECB backing was crucial for any deal. Any downgrading to default could have led the central bank to refuse to accept Greek bonds as collateral, depriving Greek banks of liquidity on which they are totally dependent.

Fitch Ratings appeared to open the door to a possible compromise last Wednesday by saying that while it would treat a rollover as a “restrictive default,” it would keep Greek bonds rated at CCC, just above default status.

“Germany is softening its stance. This is a step forward, particularly the agreement to get the ECB on board with any solution,” said Marco Valli, chief eurozone economist at Unicredit.

“But there are still big hurdles. Greece must get the austerity package through parliament. And Europe needs to come up with a way to do this rollover, which is easy to say but difficult to implement in practice.”

Battered by strikes, protests and a string of resignations in his PASOK party, Papandreou said his reshuffled government would push through the fiscal and structural reform program while doing more to stimulate growth.

 
A version of this article appeared in the print edition of The Daily Star on June 18, 2011, on page 5.

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