STRONG EXECUTION IS KEY TO SUCCESS OF EUROPE´S DEBT DEAL / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Strong execution is key to success of Europe’s debt deal

Mohamed El-Erian

July 22, 2011Print

European leaders took a big and important step towards dealing properly with the eurozone debt crisis at their summit on Thursday. This required courageous compromises on the part of many, most importantly Germany and the European Central Bank. But further design enhancements and skilful execution will be required if yesterday’s decisions are to translate into the durable restoration of growth and financial stability to the region’s troubled peripheral economies.


Debt solvency, growth and contagion have been, and are, at the core of the problems of Europe’s periphery. They speak to both the causes of this painful homegrown crisis, and to the manner in which it has been spreading. It is therefore highly encouraging that European leaders are finally taking more aggressive steps to address all three aspects.


Firstly, on solvency, the programme countries (Greece, Ireland and Portugal) will now benefit from lower interest rates and a significant extension of loan maturities.

Secondly, greater focus is being placed on promoting growth in the periphery, though this is still too restrained relative to what is required.


Finally, contagion risk – especially for Italy, Spain and the Europe-wide financial system – is being lowered through a new, flexible and fast-disbursing credit facility available both to sovereigns and banks.


This all constitutes a major step for leaders that, for almost two years, were essentially in denial. Having persisted too long with a liquidity cure for a solvency problem, they are now taking a major step towards deploying better instruments for the challenge at hand.


But success is far from guaranteed. It depends in particular on two factors: further enhancements to Thursday’s agreement, and ensuring proper execution.

As it stands, the package still lacks sufficient upfront debt relief for the most troubled economies, Greece in particular. Putting this in place quickly is central to fiscal solvency and growth promotion. Given the starting point, there is simply no substitute for some form of immediate debt reduction whose benefits flow directly to highly troubled sovereign debtors.


In addition to dealing more decisively with the crushing debt overhang, such debt relief would also assist in ensuring the proper level of overall financing and, critically, fairer burden sharing between the private sector and taxpayers.


Then there is the execution risk. Four parties will have to deliver simultaneously, and in a focused fashion, to make this package effective.


Governments in core countries – Germany, Finland and the Netherlands in particular – must convince their sceptical citizens that this is a good use of their hard-earned tax euros.


The ECB must also come up with a skilful way to compensate for the balance sheet hit it will have to take at some point on account of its peripheral bond purchases and repo operations.


Private banks must waste no time in taking advantage of favourable market reactions to raise additional capital.


Finally, the peripheral economies must deliver an internal economic adjustment that is both substantial and acceptable in socio-political terms.


History will show that, on July 21 2011 European leaders met and, jointly, stepped up to the plate to respond better to an internal crisis. But history will only label this a success if Thursday’s courageous compromises are followed by proper enhancements and skilful execution.


There is still much to do if this historic summit is to mark the beginning of the end of Europe’s painful debt crisis.


The writer is the chief executive and co-chief investment officer of Pimco