EU fumbling leaves euro zone seeking credibility

BRUSSELS (Reuters) - The European Union's inability to take quick, firm decisions has exacerbated Greece's debt crisis and increased the risk of contagion to other euro zone countries such as Portugal.

Four months of talks and summits have only just brought the EU to a point where it can release emergency funds to Athens -- a degree of indecision that financial markets have exploited and which now threatens Lisbon and possibly others.

The result, analysts say, is a crisis of confidence in the 16 countries that share the euro single currency. Winning that confidence back is going to take time and leadership, and will probably require deep structural changes to several economies.

"The problem here is the recurring inability in the European project to say brutal truths honestly and clearly and act on them in a realistic manner," said Hugo Brady, a senior research fellow at the Center for European Reform.

"The markets aren't stupid. They aren't going to be fooled by elaborate peacocking displays. They can see when reactions are credible and when they are not. Anyone could see Greece was going to need bailing out in a matter of weeks, and so that dancing around just made it worse."

Since Greece's debt problems began to loom large late last year, the EU has held two leaders' summits and several euro zone finance ministers meetings that discussed the crisis.

Whenever a decision appears to have been taken, doubts have immediately emerged, with Germany, which is critical to any financial aid package, often the culprit as it tries to placate a domestic audience unhappy about a bailout.

The Socialists group in the European Parliament laid the blame at German Chancellor Angela Merkel's door on Wednesday, saying her "policy of prevarication" was worsening a crisis that was still unfolding.

Angel Gurria, the secretary general of the OECD, a club of the world's largest economies, was equally critical. He told German radio the EU should have intervened to help Greece "two or three months ago."

"If you look back at the last weeks or months, you have to say there has been a lack of clear leadership," said Janis Emmanouilidis, a senior analyst at the European Policy Center.

"That is exactly what markets want. They are able to exploit those insecurities and uncertainties."

"KILL OR CURE" FOR EURO ZONE

As well as highlighting the EU's cumbersome decision-making, the crisis has exposed the lack of foresight that went into the creation of the euro and the process of economic and monetary union that underpins it, analysts say.

Introduced 11 years ago, in the heyday of an economic boom, the euro quickly gained strength and credibility in financial markets. But there was no provision among the countries that adopted the currency about what to do in a severe crisis.

"What the current situation shows is that they didn't have the mechanisms for bad weather conditions," said Emmanouilidis.

The fact euro zone leaders had not thought of that before, or that they weren't able to agree on crisis mechanisms at an earlier stage, underlines the lack of a clear vision, he said.

"The Greek crisis is a credibility crisis and now the euro crisis is a credibility crisis. Whatever you do, whatever you say, you will be doubted, and that makes it so difficult."

Economists have proposed that the EU set up a European Monetary Fund -- along the lines of the International Monetary Fund -- that would be tapped in exceptional circumstances. But creating such a vehicle takes time and strong political resolution, both of which the EU has in short supply.

"We are in a time of crisis management, and yet we also have to think of crisis prevention," said Cinzia Alcidi of the Center for European Policy Studies, which proposed the EMF idea.

"The monetary union was not prepared to handle this kind of situation... We need some new internal mechanisms."

If Greece's problems spread to Portugal -- and the sell off in Portuguese assets clearly indicates that financial markets think that will happen -- a number of scenarios are possible, including a wider contagion that draws in Spain or Ireland.

If the EU/IMF bailout of Greece -- which EU leaders are finally expected to activate on May 10 -- is insufficient, then Greece could default. Otherwise it might restructure its debts, although the EU says that is not possible.

In the long-run, analysts expect this crisis to force countries such as Greece, Portugal, Ireland and Spain to make deep and painful adjustments to their economic models -- cutting state spending, raising retirement ages, improving productivity and tax collection -- so that they have natural defenses.

But that can take years. In the meantime, the euro is likely to suffer and default will remain on the cards.

"The euro, if you like, is a confidence trick and there is a desire to ignore the fact that it probably wasn't an ideal currency union," said Brady, although he does not think the currency or the monetary union will fall apart.

"We're defining what sort of area the euro zone is right now ... It's really kill or cure."

(Additional reporting by Marcin Grajewski in Brussels and Erik Kirschbaum in Berlin; Editing by Dominic Evans)