Drastic actions needed to solve debt crisis

Ideas are much easier to propose than to execute.

It is hard to reshape the competitiveness of Greece and other southern European countries. These countries are confronted with declining competitiveness of traditionally dominant industries, the lack of flexibility in the labor market and heavy pension liabilities and other issues.

In addition, membership in the eurozone has made them lose many means to stimulate economic growth, such as lowering interest rates, currency devaluation and the expansion of fiscal spending. This means that these countries may still maintain low growth in the near future.

The reason that the EU has tried to prevent the five countries from breaching the agreement and restructuring their debt is that they are concerned about the breeding of moral hazard in the eurozone countries.

As European commercial banks are cross holding a high amount of national debts of these five countries, the decline in value caused by debt restructuring will once again impact the balance sheets of commercial banks, which may not only set off a banking crisis, but the ensuing credit squeeze will impact the global economy again.

In core countries, such as Germany and France in the EU, the governments are battling with public opinion. Voters in France and Germany are reluctant to use their own resources to rescue the five countries, while voters in the five affected countries refuse government proposals of achieving fiscal stability by pension cuts and tax increases.

The debt crisis will not end soon. This battle may last three to four years or even longer, with the possibility of periodic outbreaks. If this is not addressed properly, the debt crisis could negatively impact European monetary integration and the prospect of euro.

But there are some ways out of a longer financial crisis.

The EU and IMF could announce a massive low-interest loan to Greece, about 500 billion euros with an interest rate lower than 3 to 3.5 percent.

Official creditors and private creditors could reach an agreement that would allow Greece to extend the period for debt liquidation or reducing the current debt interest rate, namely soft restructuring.

If these measures don't work, Greece could breach the contracts and come to an agreement with its creditors about direct debt reduction, or hard debt restructuring.

The resurgence of Europe's sovereign debt crisis will impact the global economy.

The global aggregate demand may continue to shrink, and there would be an increase in international trade friction. The depreciation of the euro against the US dollar may appear periodically. The prices of global energy and commodities may fall.

The Chinese economy will likely be influenced by the decisions made on how to stabilize the European countries. The drop in prices of global energy and commodities may reduce imported inflation, but China will continue to face a decrease in export growth, increasing pressures on trade protectionism and the appreciation of yuan. It will also have to encounter adverse influences from inflows of short-term international capital.

The author is a researcher with the Chinese Academy of Social Sciences.

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