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World Economy Update

February 20, 2012
European officials attempting to fend off the euro area’s first sovereign default will try to settle remaining disputes today as they close in on a 130billion-euro ($171 billion) Greek bailout.
Finance ministers meet at 3:30 p.m. in Brussels, joining Greek Prime Minister Lucas Papademos , who arrived on the eve of the gathering. Their talks on his country’s second bailout in two years will aim to reconcile demands on Greek leaders, a private-creditor debt swap, the role of the European Central Bank and setting up an escrow account for interest payments.
European leaders including German Chancellor Angela Merkel want to wrest the common currency out of its crisis amid signs of improvement in the global economy. Focus has returned to Greece as the threat of economic collapse and exit from the euro has stoked officials’ concern such a scenariomay provoke chaos.
“I don’t think there will be a majority to go down any other avenue” than a Greek bailout, Austrian Finance Minister Maria Fekter told state broadcaster ORF yesterday. Her French counterpart, Francois Baroin , told Europe 1 radio today that “we have all the elements of an agreement.”
Should ministers fail to back the bailout package at their Brusselsmeeting, the issue could be pushed off to the next European Union summit on March 1. A disrupted schedule would threaten to spark unease amonginvestors and reverse a decline in bond yields in indebted nations such as Italy and Spain .
Scope ‘to Disappoint’
“Deadlines are shifted and there is scope for events to disappoint,” Neil MacKinnon , a global macro strategist at VTB Capital in London and a former U.K. Treasury official, wrote in a note to clients yesterday.
Italian and Spanish bonds continued their advance amid optimism that an agreement is in reach, while the euro gained as much as 1 percent to $1.3275 today, bringing its climb against the dollar this year to more than2 percent. The yield on the Greekbond due October 2022 declined 30 basis points to 34.09 percent. European stocks rose, with the Stoxx Europe 600 Index (SXXP) climbing 0.6 percent to a six-month high.
Merkel, Papademos and Italian premier Mario Monti expressed confidence on Feb. 17 that ministers will resolve open questions, and Papademos flew to Brussels yesterday to facilitate discussions. International Monetary Fund Managing Director Christine Lagarde also will participate in the finance ministers’ talks, according to IMF spokesman Gerry Rice.
Critical Talks
Papademos’s presence was deemed necessary because immediate coordination is required with Finance Minister Evangelos Venizelos, according to a Greek Finance Ministry official. A final meeting with Greek government officials such as Papademos and Venizelos andthe International Institute of Finance could also be required, the official said.
The German Finance Ministry is “increasingly optimistic” on agreement, though some pointsneed to be resolved, including a plan for an escrow account to ensure that Greek aid money goes to paying creditors, ministry spokeswoman Marianne Kothe said in Berlin. Euro officials have reached broadagreement with Greece on the account; “at this point it’s down to technical questions,” Kothe told reporters.
As the clock ticks toward March 20, when Greece is due to pay off14.5 billion euros of maturing debt, euro-area officials are scrambling to align competing schedules with a private- sector bond swap designed to slice about 100 billion euros off Greece’s debt.
Swap Window
Officials are targeting a window of Feb. 22 to March 9 to complete the swap transaction, German lawmakers were told during a briefing last week by government officials. The swap would then begin by March 8 at the latest and be completed by March 11, according to state-run Athens News Agency. A successful debt swap would mean that Greece won’t have to repay in full the March 20 bond.
Still, the exchange can only proceed once governments authorize funds to be used in cash or collateral as an incentive to investors. The Finnish Finance Ministry said today that final approval for the whole Greek package is “likely” to come in the week of March 12.
Compounding the issue is the role of the ECB and the Greek bonds it has accumulated over the course of the crisis. The Frankfurt-based central bank is holding talks on exempting Greek bonds in national central banks’ investment portfolios from a debt restructuring, two euro-area officials said last week.
The ECB is swapping its Greek bonds for new ones to ensure that it won’t be forced to take losses in any debt restructuring, three euro-area officials said on Feb. 16. The move may be completed today, the officials said.
Collective-Action Clauses
Greece is drawing up legislation that could be used to impose losses on investors who don’t support the debt swap, according to two euro-region officials familiar with the situation. Finance ministers are prepared to back the use of so- called collective-action clauses if the voluntary swap doesn’t draw enough participation, one of the officials said.
Meanwhile, questions have swirled on whether austerity and outside financing measures being undertaken will manage to stave off a Greek collapse. The Greek economy shrank 7 percentin the fourth quarter from a yearearlier as unemployment surgedpast 20 percent in November. The country’s output is forecast to shrink for the fifth straight year.
Debt Goals
Euro-area ministers heard on a Feb. 15 conference call that without further measures, Greece will miss debt-reduction goals. Outstanding debt would fall to 129 percent of gross domestic product in 2020, missing a targeted 120 percent, according to three people familiar with the talks.
German Finance Minister Wolfgang Schaeuble signaled flexibility on the target, saying inStuttgart on Feb. 17 that “the 120 percent may be 122 percent or 123 percent, it mustn’t be 130percent.”
Before he flew to Brussels, Papademos said his governmenthad identified the cuts necessaryto lower spending by 325 million-euros, offering more guaranteesthat Greece will fulfill its side of the bargain.
“A euro exit by one member could fundamentally change the nature of the euro as an irreversible currency and spark an unprecedented run on banks and sovereigns,” Joachim Fels , chief economist at Morgan Stanley, wrote in a note to clients yesterday.
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