Cracks appear in Europe's response to Greek crisis

Words of support for stricken eurozone economy – but no cash

(EPA)

A divided European Union retreated from launching a multi-billion euro rescue package for Greece yesterday, its leaders attempting instead to talk their way out of the worst financial crisis in the bloc's half century history. The Greek budget deficit is destabilising the entire continent but the EU's heads of government opted to issue a statement of "solidarity" with Athens. They promised that member states of the Euro will take "determined coordinated action, if needed, to safeguard financial stability in the euro area as a whole. The Greek government has not requested any financial support".

After an informal heads of government summit in Brussels prompted by the "contagion" spreading from Greece and threatening the very existence of the euro, the German Chancellor – who will have to foot the bill for any future bailouts of Greece and other weaker economies – said she stood "shoulder to shoulder" with Greece, which is "part and parcel of all of us". Similarly stout expressions of solidarity came from Nicolas Sarkozy, the French President, Herman Van Rompuy, the permanent President of the European Council, and others, but there was no mention of money.

But the EU statement stressed, as did Chancellor Merkel and President Sarkozy, that Greece has not yet formally requested financial assistance, though few doubt that Berlin and Paris have been drawing up contingency plans for the day it does.

One EU source said deep tensions over Greece remain, with the additional presence of Jean-Claude Trichet, the President of the European Central bank, proving less useful than might have been hoped. "The atmosphere between Merkel, Sarkozy and Trichet was not good during their breakfast meeting. They are not on the same page, even though everyone expected them to be" said one insider.

"The Germans and French see the problem very differently. And Trichet has a very legal view on what the EU can and can't do. But other nations are expected to come on board in terms of offering loans and guarantees."

The markets seem to have taken the EU at its word, at least for now, and the euro finished little changed against other leading currencies.

The Greek government has agreed to achieve the radical reduction in its budget deficit, the largest in the EU in proportion to the size of its economy. Currently approaching 13 cent of GDP, Greece has promised to lop 4 percentage points off that next year and to bring it back to the permitted level of 3 per cent of GDP by 2012.

A wave of public sector strikes, including one by tax collectors, has undermined an already shaky faith in the Greek government to deliver on its austerity measures. To bolster confidence Greece has agreed to a monthly assessment of public finances by other EU governments, and for the IMF to oversee its fiscal policies. Athens already agreed to have European Commission officials reform their statistical systems.

EU officials say the promise that concerted financial support will be forthcoming "if needed" is designed to restore confidence and avert that action becoming necessary.

That is key for Germany. There was much muttering from the German side that is not politically possible for Berlin to simply "open up the coffers". A legal study commissioned by the German Bundestag suggested that a bailout of Greece would be unconstitutional. It is also, technically, illegal under EU rules for one nation to assume the debts of another though ways could be found around such obstacles if necessary.

Being outside the eurozone, the UK will not be expected to contribute much, if anything, to any future financial aid for the so-called "Pigs" – Portugal, Ireland, Italy, Greece and Spain.

Attention is turning to what permanent arrangements the EU can implement to prevent problems in one member engulfing the entire eurozone. Berlin fears that any economic government, analogous to the US Treasury, might become profligate and irresponsible, and threaten the independence of the European Central Bank. The original Maastricht rules limited national budget deficit to 3 per cent of GDP and national debts to 60 per cent of GDP, but they were swept away as nations tried to spend their way out of recession.

Explainer: The EU's reply to Greece

Q. Will this end the crisis?

A. Yes, but not for long. The problems facing Greece's public finances are profound and not easily fixed – even if the others bully the Greeks and put them "on report". The fact that the Greek Prime Minister will have to report back on his progress every month won't calm political opposition, nor end the strikes.

Q. How much will it cost the UK?

A. Nothing, probably. Outside the eurozone, the UK is immune from any immediate fallout from the crisis. But we might still have to stump up if if the IMF has to bail out Greece. And if our biggest economic and trading partner by far, the eurozone, is in crisis, that is bad for trade, investment flow and jobs over here.

Q. How much would a bailout of Greece cost?

A. About €20bn (£17bn) – but much more if the "contagion" spreads and infects all the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain). If the crisis got that big, not even the Germans would be able to bail them all out.

Q. Is sovereign debt the "new sub-prime"?

A. It looks like it. Greek government bonds give you a return of almost 7 per cent – but with the risk of default. Default could spark a massive sell-off of government bonds within the eurozone and maybe further afield, representing a gigantic destruction of wealth. So Greece may be small – 3 per cent of EU GDP – but it could start something that would make sub-prime look like a tea party.