Euro zone debt deal tackles symptoms not cause

Euro zone leaders are as far as ever from finding a lasting solution to the bloc's underlying problem of economic divergence, despite their latest progress in managing the symptoms of its debt crisis.
The complex agreement reached in Brussels in the early hours of Thursday lends credence to the view that the euro zone will somehow muddle through. But it is not the Grand Plan that optimists had hoped for: what was the 14th summit in less than two years to tackle the crisis will not be the last.
"This is another step in the right direction, but it is not enough to get us to the end game," said Stephane Deo, chief European economist at UBS. "It buys time but it does not address the fundamental problem of the sovereign debt crisis."
European equities and the euro rallied after the summit exceeded markets' modest expectations. Banks agreed in principle to a 50 percent reduction in the face value of their Greek bonds and leaders said they intended to increase the firepower of their financial rescue fund to 1 trillion euros ($1.4 trillion).
But nearly 35 percent of Greek bonds is in the hands of public institutions such as the European Central Bank (ECB) and is not subject to the mooted writedown. As a result, Greece's debt would still be an eye-watering 120 percent of gross domestic product in 2020 -- exactly the level of late 2009.
And even that assumes decent economic growth and ambitious structural reforms including large-scale privatisation of state assets.
"From the macroeconomic point of view, if it's purely a 50 percent 'haircut' on the nominal bonds, without an extension of the maturity and a reduction of the coupon, I'd still be reasonably suspicious about the sustainability of Greek debt," Deo said.
Greece, however, has become something of a sideshow. Investors long ago judged that it was not just illiquid, but insolvent. Much more critical is what the euro zone could do to prevent the debt rot from spreading to bigger, systemically important but stagnant economies, notably Italy.
Markets will have to wait for details as to how the European Financial Stability Facility will be scaled up; whether the likes of China will top up the bailout fund; and how operationally it will enhance the credit of member states' new bonds.
But some analysts are sceptical. Economists at Royal Bank of Scotland said they expected markets to reprice sovereign debt across the euro area given the size of the losses imposed on Greece.