Chancellor Merkel vs. The World

With Greece’s bond swap agreement approved, it seems that their debt problems are now over. But elsewhere in the euro zone region, it looks like new hurdles are coming into light.

One major issue that is brewing is that the current austerity measures that some euro zone members have put in place might not be enough to keep their debt in check. Policymakers in the region are saying that confidence is of utmost important and it needs to be restored. To do this, they are demanding that stricter austerity measures be implemented.

For instance, Spain, which is euro zone’s fourth largest economy, could follow Greece’s footsteps if it does not keep a handle on their finances. Around a week ago, Spanish government officials revealed that they had decided to revise the country’s budget deficit forecast from 4.4% of GDP to 5.3%. Needless to say, that is a huge number as it is significantly higher than the European Union’s 3% maximum rate requirement.

With these troubles brewing, euro zone needs to prepare itself for the worst with its rescue funds. Unfortunately, euro zone can’t seem to agree on what they’re going to do next.

European Commission: Increase the Bailout Funds

The U.S., together with the International Monetary Fund (IMF) and the European Central Bank (ECB), has been pushing Germany to take a more pro-active approach to the bailout funds. If the fund is increase, it could convince investors that the region has a viable contingency plan in dealing with the debt crisis.

The IMF and the ECB believe that putting more money would reassure investors and creditors that their contributions won’t be used. This could create a snowball effect, and encourage them to invest even more money.

Chancellor Merkel: Allow ESM and EFSF to Run Together

However, German Chancellor Angela Merkel isn’t pleased with this plan at all. Instead, she is suggesting a temporary boost to the euro zone’s bailout funds from 500 billion EUR to around 700 billion EUR, which would still be short of the European Commission’s proposed 1 trillion EUR expansion.

Under Merkel’s suggestion, the permanent European Stability Mechanism (ESM) would remain capped at 500 billion EUR but it would be allowed to operate along with the temporary European Financial Stability Facility (EFSF) until next year. With roughly 240 billion EUR still left in the EFSF, letting the two funds run in tandem could create a firewall with a lending capacity of more than 700 billion EUR.

Bear in mind though that 200 billion EUR out of the existing EFSF is already allotted to Ireland, Portugal, and Greece, which leaves only 500 billion EUR in new lending capacity.

Of course nothing is set in stone yet as the final decision on the funds’ expansion depends on the upcoming meeting among euro zone finance ministers in Copenhagen at the end of this month. Although Merkel strongly believes that an unreasonably large firewall could destroy the credibility of European governments, she might still be persuaded to shift her stance during the summit. After all, she showed willingness to compromise and already retreated from her long-held refusal to expand the fund at all.

There is a lot at stake on this finance ministers’ meeting. Unless the euro zone manages to restore confidence on its financial standing, the IMF might decide against doubling its contribution to the euro zone bailout funds. With plenty of dark clouds still looming on the euro zone’s horizon, it needs all the help it can get.