Greece Activates Emergency Bailout, Testing Financial Strength of Eurozone Countries

Greece on Friday officially asked to tap into a $60 billion (45 billion euro) emergency aid package after months of talks, setting into motion a bailout process that will put the financial strength of Eurozone nations to the test.

Greece Prime Minister George Papandreou called his debt-stricken country's economy a "sinking ship," as borrowing costs reached 12-year highs and recent austerity measures didn't rally the market support needed to save Greece.

"This is the moment. The time that was not granted to us by the markets will be given to us by the support of the Eurozone," Papandreou said.

The request came a day after the yield on Greece's benchmark two-year note topped 11%, ten-year bond yields reached 8.83%, and Moody's Corp. (NYSE: MCO) downgraded the country's credit rating one notch to A3  - the second downgrade this year. European Union statistics service Eurostat on Thursday revised Greece's deficit to 13.6% of gross domestic product (GDP) in 2009, up from 12.7%, questioning the country's ability to reduce the budget deficit to 8.7% this year as planned.

Greece is facing $11.4 billion (8.5 billion euros) of bonds maturing on May 19 and hopes a request made now will speed up the bailout process in time to meet that deadline.

The aid package will give Greece $40 billion (30 billion euros) in three-year loans from its fellow Eurozone nations at around a 5% interest rate, and an additional $20 billion (15 billion euros) from the International Monetary Fund (IMF) will be available at an even lower rate. The offer was announced a couple of weeks ago in hopes the pledge of support would be enough to encourage investor confidence.  

The news of an official request did not significantly move the markets. The euro - down 7% this year - rose slightly on the news from $1.3261 to $1.311, and Greece's ASE stock index rose 1.5% to 1892.32. Greece's two-year yield barely moved, hovering around 10.5%. 

Short-Term Solution for Long-Term Problem

While this initial bailout package could cover Greece's debt obligations for 2010, analysts say it hardly eradicates financial worries.

"The aid package will buy Greece time this year," Colin Ellis, European economist at Daiwa Capital, told Bloomberg. "That's all that it has done. Greece still faces a Herculean task to show that it can get its public finances in order."

The Economist estimates Greece will run up an additional $89 billion (67 billion euros) in debt by 2014, doubting Greece's ability to make effective budget cuts while trying to emerge from a recession. As debt piles up, investors will be less likely to buy Greek bonds and austerity measures will limit economic growth.

"In the longer-term, it's just sticking plaster over the situation," Daragh Maher, deputy head of forex strategy at Credit Agricole CIB, told Reuters.

If Greece does need more aid for years to come the result could be a series of loans from its Eurozone counterparts, what The Economist called a "fiscal drip-feed."

Sovereign debt issues have already spread to other Eurozone nations and are escalating with Greece's situation. Spain, Portugal and Ireland already faced increasing bond yields this week, strengthening the argument that Greece is the start of a debt contagion spreading through Europe to the United States.

"[T]his crisis has moved beyond being just a Greek crisis. It is a sovereign risk crisis stemming from the collapse of the traditional G7 growth model of high indebtedness and a low share of exports in the economy, which affects not just Greece but also countries such as Spain, Italy, the UK and the US," Lena Komileva, head of G7 market economics at Tullett Prebon, told the Financial Times.

German Reluctance

The request needs approval from the other 15 Eurozone countries including Germany, which has been the biggest opponent to a bailout and criticized Greece for digging its own debt hole. But despite a feared backlash from German citizens, Chancellor Angela Merkel signed the deal on April 11 to offer Greece aid if needed.

"We in Germany are pledged to solidarity and we will show it," Michael Offer, a spokesman for the Finance Ministry, told The New York Times. "We're doing this to stabilize the euro, which means it's also in our own national interest."  

Germany's reluctance to help stems from a European Union clause that prohibits bailouts and the fact that Greece manipulated statistics to join the euro-using countries after initially failing to qualify.

But Money Morning Contributing Writer Jon D. Markman explained that Germany has a lot to lose if Greece defaults since it contributes about a third of all Eurozone capital

"I encourage you to see this latest news not as a rescue for Greece, but as a rescue for Greek debt holders worldwide," Markman said. "Greece is not going to disappear as a country no matter what happens. But if a default is declared, it's the debt holders that are hurt. So all of this maneuvering must be seen in the same context as the bank bailouts in the United States: much more vital for ex-buyers than ex-sellers. Make no mistake: This is precisely why I say that this would be a bailout of Germany, not Greece."

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