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Not even the end of the beginning

WSJ analyzes why investors are still betting down Euro and Greece:

This is not the beginning of the end, not even the end of the beginning. The International Monetary Fund and euro zone’s €110 billion ($145.37 billion) three-year Greek debt support package still needs to be given final approval by 15 euro-zone leaders. They in turn must satisfy themselves—and their national governments and voters—that there’s a reasonable chance their loans can be refinanced, rather than turning into a straight fiscal transfer. That’s far from certain.

First, the plan does not buy Greece quite as much time as it appears. Of the €110 billion headline figure, €10 billion is going to a Financial Stability Fund to support Greece’s banks. Greece needs around €30 billion for 2010; for 2011-2012 debt and interest payments alone total €93 billion, according to Barclays Capital. So even with the program, Greece is likely to need to return to the markets in late 2011 or 2012. Ideally it would return as soon as possible, if the plan works.

Second, debt will still be rising in 2011 and 2012, topping out only in 2013 at an eye-watering 149% of GDP. In 2012, the budget deficit is still forecast to be 6.5% of GDP. Greece’s credit ratings may then be even lower than they are today; this may further complicate market access. Bond investors will have to be convinced already in 2011 that the debt trajectory and economy will turn around decisively, in order to engender private interest in Greek debt.

True, the new plan is at least realistic, recognizing the damage the economy will suffer: Greek GDP is assumed to shrink 4% in 2010 and 2.6% in 2011, before growing just 1.1% in 2012. The total fiscal adjustment of 11% of GDP is now in line with economists’ assumptions of the scale of effort necessary. And there will be quarterly monitoring of progress; International Monetary Fund involvement should boost credibility.

But the deal faces substantial execution risks: The Greek government is facing growing domestic opposition to its new austerity program announced last weekend, which includes further public-sector pay cuts and a VAT increase. Success also depends on global growth remaining robust as Greece is ill-equipped to deal with any fresh external shocks.

Euro-zone leaders may persuade themselves they have to endorse the package since any alternative, such as a restructuring, would be so traumatic. But they need to be clear about the risks: Even if the Greek economy performs in line with the IMF’s projections, they may yet need to provide further support packages as private lending starts to re-engage. The euro-zone’s engagement with Greece is likely to be a lengthy one.

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