WHY THE GREEK RESCUE ISN´T GOING TO PLAN / THE FINANCIAL TIMES COMMENT & ANALYSIS ( VERY HIGHLY RECOMMENDED READING - A MUST READ )

Why the Greek rescue isn’t going to plan

By Mohamed El-Erian

Published: April 7 2010 15:53

It should be apparent to all by now: despite the rhetoric out of some European capitals, the Greek rescue package is not going according to plan.

The triumphant Greece/European Union/International Monetary Fund announcement of a couple of weeks ago has not calmed markets, nor has it lowered Greek borrowing costs. In fact, market measures of risk signal more concern today than before the announcement.

Meanwhile, worries are mounting about the health of the Greek banking system, raising the spectre of disorderly outflows of deposits. Society is not buying into the government’s adjustment plan. And the EU/IMF external financing package lacks the operational clarity that is required in these circumstances.

Veterans of past sovereign debt crises will not be particularly surprised by this turn of events. As illustrated by Mexico in 1995 and Korea in 1997, among many others, complicated sovereign rescue packages often have to be re-opened. In some cases, such as Russia in 1998 and Argentina in 2001, the packages never succeed in getting ahead of deteriorating debt dynamics.

Unfortunately, it is likely that things will get worse for Greece before they get better. In the short run, the persistence of alarming risk spreads will lead to even more cautious behaviour among depositors and investors. Late movers will sell Greek assets rather than buy, putting even greater pressure on the government’s ability to raise sustainable funding for its forthcoming debt maturities in May.
Against this background, we should expect an intensification of the European blame game in the weeks ahead. Greece will complain about the lack of meaningful support from its European neighbours. They, in turn, will point the finger right back, noting the urgent need for Greek austerity. And the IMF will be pulled in all directions, including by those hoping that the institution can engineer an immaculate recovery for Greece.

Ironically, the major issues in this complex case can be summarised by a relatively simple observation: that the solution to Greece’s problems is undermined by the inability of the major players credibly to commit to the required high level of co-ordination and trust.

The Greek government is having difficulty convincing its people of the magnitude of the country’s problems and the required internal adjustments. As a result, Greece is unable to provide sufficient assurances to its creditors, thereby further complicating an already tough situation. This accentuates the hesitancy of exceptional financiers, such as Germany, who resist having to again pay the bill after others have partied. And without exceptional financing, the Greek government finds it even more difficult to embark on an adjustment program that relies on only one instrument – that of fiscal austerity.

It is a classic co-ordination failure in game theory. Any first mover will become worse off. Indeed, it is in the interest of any single party to wait for others to move first. As a result, no meaningful progress is made, the problems fester, and the risks of a disorderly outcome increase.

Buoyed by a cyclical recovery, markets around the world have yet to recognise the complexity of this situation. When they do, it will also become apparent that Greece is part of a wider, and historically unfamiliar phenomenon – that of a simultaneous and large disruption to the balance sheet of many industrial countries. Tighten your seat belts.

Mohamed El-Erian is chief executive and co-chief investment officer of Pimco

Copyright The Financial Times Limited 2010.