What next for the Euro?

The worst fears that the single-currency Euro will not survive look like coming true. Though the Greek soap opera acted out by George Papandreou over conducting a referendum has been contained, it is not Greece alone that holds the key to a more stable Euro. The fundamental problems that are threatening larger and more crucial economies within Eurozone such as Italy and Spain concern slower growth over the last decade. If one looks at data released by the European Central Bank, Italy has grown at an average of 1.5 per cent between 2000 - 2007 while interest rates stood at 4.5 per cent. Hence the country needed to sustain economic growth rates at nearly 4 per cent for some time or bring down the interest rate considerably. While the former is not achievable for an indefinite period, the latter stands to be addressed. There are in fact no quick fixes for the current crisis. As pointed out by Thomas Mayer of Deutsche Bank, "below the surface of the euro area's public debt and banking crisis lies a balance-of-payments crisis caused by a misalignment of internal real exchange rates". Hence the crisis can be averted only when the weaker economies in Eurozone regain their competitiveness. As things stand now, the structural external deficits of these troubled economies have reached a volume too large for refinancing by the individual countries themselves. Again bailout packages that have been forthcoming have proved too little too late. A series of efforts including a proposal advanced in July this year for writing off 20 per cent of loans lent to Greece by private lenders fell flat on its face as French and German banks were large stakeholders of Greek debt. When eventually in October, the eurozone came up with a plan to expand the European Financial Stability Facility to one trillion dollars where banks agreed to write-off half of their Greek holdings, it was bulldozed by Papandreou's theatrics on holding a referendum. Thankfully, Mr. Papandreou has backed down from his high perch and the plan is back on track while the Greeks work towards forming a national unity government. Having averted a potentially destabilizing Greek meltdown, all eyes now rest upon Italy. With the ubiquitous Berlusconi seemingly on his way out, reforms are expected to contain the 'contagion' of debt-default that plagues eurozone. Italy's problems are fundamentally different from Greece's in that the Italian economy is inherently weaker than its European counterparts. The country is plagued by poor regulation, an ageing population and weak investments. Consequently, Italy has posted a growth rate of about 0.75 per cent over the past 15 years, which in effect, is a rate that is far lower than the rate of interest it must pay on its debt. Lower growth has prompted potential lenders to demand a much higher rate of interest on loans the Italian government will need to repay old debts. The higher interest rates that have now reached an abnormal 7.0 per cent make the whole issue of repayment by Italy highly suspect. Policymakers and market analysts all agree that if markets panicked and opted out of Italian debt altogether, a potential bailout of the Italian economy would make the 440 billion-euro Greek package look like a pigmy - a scenario all parties would like to avoid at any cost. Much now rests on whether Italy's economic growth picks up to a level that will assuage market fears.