Papandreou asks Greeks to accept ‘great sacrifices’

With minds focused by signs of Greek's debt problems spreading to other southern European nations, a €110 billion bail-out by the European Central Bank and the IMF to stop Greece defaulting on its debt has finally been agreed.

But Sunday's accord has not satisfied investors that the Eurozone crisis is over. The currency continued to sink yesterday and the cost of Greek borrowing dropped only slightly to 10 per cent. Investors believe Greece is unlikely to transform itself into a nation of hard-working taxpayers and trim its budget deficit to below the EU limit of three per cent of gross domestic product by the end of 2014.

In Athens, civil unrest suggests Greeks themselves are still unwilling to accept austerity measures required to meet the terms of the three-year deal. "I want to tell Greeks very honestly that we have a big trial ahead of us," Prime Minister George Papandreou said over the weekend. He urged Greeks to accept "great sacrifices" to avoid "catastrophe".

Market analysts warn that Greece's fundamental economic problems will not be solved by austerity measures and that tax hikes may not be politically sustainable anyway. Deflation is the main threat to Greece's economy - a blow that public spending cuts may only serve to exacerbate.

"How can Greece grow out of its debt if there is deflation?" asked Jean-Paul Fitoussi, a professor of economics at the Institut d’Études Politiques in Paris. "Deflation increases the debt burden, so we are following this virtuous circle that is bringing us towards hell. Economics has nothing to do with virtue, which can kill an economy."

Nor will the Greek deal serve to lessen concern over other members of the PIGS bloc. After all, where one pig goes, others may follow. Greek-style challenges are almost certain to await Portugal, Spain and perhaps even Italy as well as peripheral Eurozone nations like Latvia, Hungary and Romania - even the UK - that are faced with slow-growing economies and massive debt and budget problems.

"The immediate impact (of the Greek bail-out) may be soothing, but the inflammation will soon show up again," said Edward Hugh, an economist in Barcelona who writes for the influential Fistful of Euros blog. "My feeling is the rot has now gone too far."

Still, IMF and ECB officials have been talking up the deal. "I think that the result is fully in line with what we very much wanted," Jean-Claude Trichet, president of the ECB, told a news conference in Brussels.

In truth, it may not be what ECB bankers want - but it's the best of a set of poor alternatives. After all Greece, as a member of the Eurozone, could not devalue its currency, only default on loans. And who carries a vast amount of those loans on their books? German and French banks.

No wonder then that the French in particular have been keen on a bail-out. The Greek deal "is an indirect way of bailing out French and German banks," Fitoussi told the New York Times. "The French understood this from the start, but Germany didn't seem to."

Katinka Barysch, deputy director of the Centre for European Reform in London, explains: "It might be unpopular for the Germans and Europeans to bail out Greece, but it will be even more unpopular for them to bail out the banks that owned Greek bonds."

But if the austerity programme imposed on Greece proves unsustainable, the central European bankers will find themselves without the credibility needed to negotiate rescues down the road - and that could end up threatening the euro and the Eurozone itself. ·