BRUSSELS (Reuters) - By adopting a more nuanced approach to their debt crisis, euro zone leaders may be on the verge of stemming the contagion that only weeks ago seemed set to overwhelm the bloc by enveloping Portugal and its larger neighbor Spain.
Throughout the latter half of 2010, the bloc’s only real answer to the crisis was the 750 billion euro ($1,017 billion) rescue facility it cobbled together under acute duress following its shock bailout of Greece in May.
The facility’s big headline number — a combination of EU and IMF funds including the bloc’s 440 billion euro European Financial Stability Facility (EFSF) — restored calm at first, but markets soon began to view it as a last-resort bazooka and set out to test it and the resolve of the leaders who set it up.
It has taken the politicians and technocrats many harrowing months to realize the flaws of their initial strategy. In response they are now edging toward a more nimble, flexible and broad-based approach for handling a crisis which some experts still believe could doom the single currency experiment or force out a member.
“We need to get ahead of the crisis and be able to respond to it more subtlety,” said a senior euro zone official directly involved in structuring the EU’s crisis response.
“We don’t like this situation where the market is able to drive a country across some red line and then we’re in crisis mode and have to arrange an 80 or 90 billion euro bailout when it’s almost too late, when a much smaller amount of money earlier might have helped control the situation,” she said.
In discussions that have taken place at meetings of euro zone finance ministers over the past two months, and among economic and finance officials at frequent gatherings, the focus has been on how to deploy the EFSF more cleverly, to enhance it as European Central Bank President Jean-Claude Trichet says both “quantitatively and qualitatively.”
The quantitative approach has involved looking at how the effective lending capacity of the EFSF, which is limited by cash buffers and other guarantees, can be raised from around 250 billion euros currently to its full ceiling of 440 billion.
There is also discussion about raising the overall size of the fund and possibly doubling it, although Germany, as the largest provider, remains reluctant.
But it is the qualitative approach that is revealing most about how policymakers are trying to be more creative in tackling a crisis that has rumbled on for nearly a year.
No specific decisions have yet been taken — and may not be until EU leaders meet to discuss next steps at a summit on March 24-25 — but trial balloons and proposals are being released that suggest some of the tactics under consideration.
Officials have mooted the possibility of the EFSF being used to buy bonds directly in the secondary market, or to make loans to troubled countries to allow them to buy their own bonds. Both moves could help bring down bond yields and lighten the burden on sovereign debt markets while increasing confidence.
There are also efforts to diversify funding, with countries such as Portugal, Greece and Spain looking to make private placements of debt, or sell bonds through syndication.
Market concerns about troubled banking sectors are also being addressed. Last week Spain announced plans for a partial state takeover of its weakest savings banks, winning plaudits from investors and ratings agency Moody’s..
Euro zone countries have also sought help from their foreign partners. China has publicly promised to buy government debt from Greece and Spain. Japan and Russia are also mentioned as possible buyers of euro zone sovereign bonds.
Whether it is the result of this more nuanced approach or more market-driven factors, such as a broader shift in the focus of hedge funds away from the euro zone’s woes, investors appear to be coming around.
Yields on peripheral euro zone debt have fallen in recent days and the cost of protecting lower-rated euro zone sovereign debt against default has dipped sharply in the past two weeks.
“There are growing expectations that the European authorities will announce a more substantive fiscal policy by the March summit meetings,” Nick Stamenkovic, a debt strategist at RIA Capital Markets, said on Monday in explaining the more positive tone in European markets.
Analysts who have closely followed the debt crisis over the past year believe policymakers are having more success at getting ahead of the market, and believe Germany has adopted a more pragmatic approach that has helped settle agitation.
“The fact that there is more calm on the markets is from the EU and euro zone perspective a good thing,” Janis Emmanouilidis, a senior analyst at European Policy Center, told Reuters.
“If in a few weeks’ time, at the March summit, they can come up with some concrete proposals (on the EFSF), that could be the positive blow that gets them ahead of the markets,” he said.
But he and others caution that this is just the short-term approach. The fundamental issue underpinning the crisis is the need to restructure the economies of weaker euro zone countries, making them more competitive, raising growth, tackling unemployment and reining in excessive spending.
That is a multi-year process that is part of the EU’s efforts to strengthen the stability and growth pact. In the short-term, what is required is a nimble strategy that allows the euro zone to pre-empt problems before they begin.
“We know what we need to do and where there are problems,” said the senior euro zone source. “But part of the issue is getting sovereign countries to adopt the strategy, getting them to preempt the problem and react before it blows up.”
Additional reporting by William James in London; editing by Noah Barkin