Greek Aid Pact May Be ‘Defining Moment’ For Euro Fiscal Policy

European leaders’ pledge to help Greece with an unprecedented aid package may be a stepping stone on the way to a more unified fiscal policy, said economists at Barclays Capital and Commerzbank AG.

“It’s a defining moment,” Julian Callow, chief European economist at Barclays in London, said in an interview . “We have countries coming together able to help and give assistance to one of their number in the euro area.”

Euro region officials have spent the past two months debating whether to maneuver around the rules of the Maastricht Treaty, which left the bloc without a common finance ministry to match its shared central bank. The treaty also contains a “no bailout clause,” making it harder for governments to agree on fiscal transfers for euro members facing fiscal crises.

The lack of clarity on how Greece could be rescued as it struggles to cut the European Union’s largest budget deficit contributed to the euro’s 5 percent decline this year. Investors also dumped Greek bonds, pushing the yield on the benchmark 10- year bond to an 11-year high of 7.51 percent on April 8.

“Only recently, it would have been unthinkable for one country to bail out another,” said Christoph Weil, a senior economist at Commerzbank AG in Frankfurt. “Markets forced leaders to unite and come up with a solution.”

Bond Sales

Euro region finance ministers yesterday offered Greece a 30 billion-euro ($41 billion) aid package which would give it three-year loans at 5 percent if it can’t raise money in capital markets. Bonds rebounded today, pushing the yield on the Greek 10-year bond to 6.655 percent. The gap with German bunds narrowed 50 basis points to 348 basis points.

Investor confidence in Greece will be tested tomorrow when it offers a combined 1.2 billion euros of 26- and 52-week bills. So far Greece, whose deficit was 12.9 percent of gross domestic product last year, says it won’t need to trigger the package.

Some economists say the EU needs to be more organized in future if the Greek crisis is to be contained.

“The hotch-potch way they’ve put the package together wouldn’t have been feasible for the likes of Spain,” said Colin Ellis, an economist at Daiwa Capital Markets Europe Ltd. in London.

Spain is trying to push its own deficit from 11.2 percent of GDP last year below the EU’s limit of 3 percent in 2013. Prime Minister Jose Luis Zapatero told the Financial Times in an interview published today that he will cut the shortfall “whatever the cost.”

Portugal Bailout?

Portugal is also struggling to cut its deficit and former International Monetary Fund chief economist Simon Johnson said today the EU should consider a “pre-emptive” package for the country.

Nor has the Greek rescue addressed the moral hazard of helping a country that lived beyond its means, says Paul Mortimer-Lee, head of market economics at BNP Paribas SA in London. Ireland, which is battling its own fiscal crisis, may have to pay into the fund for Greece under the terms of the EU agreement.

“The Greek decision has introduced, or increased, the incentive for governments to avoid tough choices and to let their finances drift,” said Mortimer-Lee. “By removing the tail risk that financial problems could lead to disaster, the temptation will be for governments to take more risks.”

That may force EU leaders to come up with a new set of tighter fiscal rules to prevent those risks from transpiring.

The Greek agreement “opens the door to a new world they hadn’t foreseen,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. “Since the euro is in place, it’s definitely the most important decision. Moving forward, every member state may have to give up some sovereignty on their public finances.”