Over the past couple of years, Europe has muddled through a long series of crunch moments in its debt crisis, but this September is shaping up as a make-or-break month as policymakers run desperately short of options to save the common currency.
Crisis or no crisis, many European policymakers will take their summer holidays in August. When they return, a number of crucial events, decisions and deadlines will be waiting.
"September will undoubtedly be the crunch time," one senior eurozone policymaker said.
In that month a German court makes a ruling that could neuter the new eurozone rescue fund, the anti-bailout Dutch vote in elections just as Greece tries to renegotiate its financial lifeline, and decisions need to be made on whether taxpayers suffer huge losses on state loans to Athens.
On top of that, the eurozone has to figure out how to help its next wobbling dominoes, Spain and Italy - or what do if one or both were to topple.
"In nearly 20 years of dealing with EU issues, I've never known a state of affairs like we are in now," one eurozone diplomat said this week. "It really is a very, very difficult fix and it's far from certain that we'll be able to find the right way out of it."
Since the crisis erupted in January 2010, the eurozone has had to rescue relative minnows in Greece, Ireland and Portugal as they lost the ability to fund their budget deficits and debt obligations by borrowing commercially at affordable rates.
Now two much larger economies are in the firing line and policymakers must consider ever more radical solutions.
If Spain, the eurozone's fourth biggest economy and the world's 12th, loses affordable market financing the next domino at risk of falling is Italy - the eurozone's third biggest economy and a member of the G7 group of big wealthy nations.
A bailout of Spain would probably be double those of Greece, Ireland and Portugal combined, while Italy's economy is twice as large as Spain's again.
The European Union has already agreed to lend up to 100 billion euros to rescue Spanish banks. One eurozone official said Madrid has now conceded that it might need a full bailout worth 300 billion euros from the EU and IMF if its borrowing costs remain unaffordable.
DEFLATING LIFE RAFT
The eurozone does not seem to have enough cash in the current setup to deal with a scenario of Spain and Italy needing a rescue, and a sense of doom is growing among some policymakers. Fighting the crisis, said the eurozone diplomat, is like trying to keep a life raft above water.
"For two years we've been pumping up the life raft, taking decisions that fill it with just enough air to keep it afloat even though it has a leak," the diplomat said. "But now the leak has got so big that we can't pump air into the raft quickly enough to keep it afloat."
Compounding the problems, Greece is far behind with reforms to improve its finances and economy so it may need more time, more money and a debt reduction from eurozone governments.
If Greek debt cannot be made sustainable, the country may have to leave the eurozone, sending a shockwave across financial markets and the European economy.
Sept. 12 is a crucial date in the European diary. On that day the German Constitutional Court is scheduled to rule on whether a treaty establishing the euro zone's permanent bailout fund, the 500 billion euro European Stability Mechanism (ESM), is compatible with the German constitution.
A positive ruling is vital, because Germany is the biggest funder of the ESM, and the eurozone would be powerless to protect Spain or Italy without the ESM.
On the same day, parliamentary elections are held in the Netherlands where popular opposition to spending any more money on bailing out spendthrift eurozone governments is strong. The Dutch vote may complicate talks on a revised second bailout for Greece, which also has to be agreed in September.
Athens wants two more years than originally planned to cut its budget deficit to below 3 percent of GDP, so as not to impose yet more spending cuts on a country which is already in a depression.
This would mean Greece's 130 billion euro second bailout package may need to be increased by 20-50 billion euros, according to estimates by some eurozone officials and economists, and there is no appetite in the eurozone to give Greece yet more extra money.
More importantly Greece needs to bring its debt, which is equal to 160 percent of its annual economic output, under control. This means eurozone governments, which own roughly two thirds of it, may need to write part of it off.
Private creditors have already suffered a huge writedown in the value of their Greek debt holdings but so far eurozone taxpayers have not lost a cent on any of the bailouts.
LAST CHANCE OPTIONS
Policymakers are working on "last chance" options to bring Greece's debts down and keep it in the eurozone, with the ECB and national central banks looking at also taking significant losses on the value of their bond holdings, officials said.
If governments swallowed the bitter pill by also accepting a cut in the value of their contributions to loans already made to Greece, this would break a taboo and could provoke demands for similar treatment from Ireland or Portugal.
Peter Vanden Houte, chief economist at ING bank, said euro governments might be forced to accept a halving of the value of their Greek debt - known in the business as haircut.
"If Greece is to be saved, we must see some debt forgiveness from eurozone governments in the coming years because otherwise Greece is never going to come out of the situation it is in now," he said. "We are talking about potentially a 50 percent haircut, which would still mean the Greek debt would be (proportionately) around the eurozone average."
The eurozone would want concessions from Athens. "Most probably in exchange, eurozone partners will be more strict on Greek compliance with structural reforms and may ask Greece to give up some sovereignty," said Vanden Houte.
While no official discussions are underway on another Greek debt restructuring, eurozone officials say privately it may be necessary if Greece is to have a fighting chance.
"The Greeks might say they are in such a mess that to survive they we need to ease up the austerity a bit, and to still regain debt sustainability they will have to default on 30-40 percent of the loans," one euro zone official said.
"There would be a lot of people saying this is understandable, so maybe this makes sense and maybe we could have a reasonable discussion among the member states on how Greece can move forward," the official said.
The official speculated that eurozone debt forgiveness for Greece could be made dependent on progress in structural reforms or that it could be reviewed once Athens has to start paying back the capital of the loans in 10 years.
"Maybe we could agree to give debt relief of, say, 25 percent to make possible some changes in the program. Then we implement that for six months or a year and maybe we find out that we need to give them another 25 percent and at the end of the day we might get to a stable situation," the official said.
The situation will become clearer once international lenders produce a new debt sustainability analysis for Greece at the end of August.
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