EU burying head in sand on eurozone defaults, think tank warns

May 3, 2011, 16:38 GMT

Brussels - The European Union's stated policy that it will consider no restructuring of sovereign eurozone debt before 2013 is 'clearly untenable,' a leading Brussels think tank concluded on Tuesday.

'The EU's 'read my lips: no-restructuring-until-2013' sets an arbitrary and non-credible deadline,' Alessandro Leipold from the Lisbon Council argues in 'Thinking the Unthinkable - Lessons from Past Sovereign Debt Restructurings.'

The message came amid widespread speculation over the need for debt restructuring in Greece, while EU economy commissioner Olli Rehn insisted on Monday that supporters of such a course of action 'seem to ignore (its) potentially devastating implications.'

But Leipold, a former International Monetary Fund director says that 'the writing on the wall for Greece seems to be increasingly clear.'

The EU insists that 'haircuts' - forcing bondholders to accept partial losses when debtor countries struggle to repay their debts - are out of the question until a new eurozone bailout fund - the European Stability Mechanism (ESM) - is introduced in July 2013.

This, Leipold says, is 'primarily due' to the fact that ESM loans should enjoy preferred creditor status, shielding them from default, while current eurozone bailout aid does not have that protection.

But waiting two years to make governments' loans to fellow eurozone members default-proof will only make the underlying problems in bailed out Greece, Ireland and soon-to-be rescued Portugal worse, the Lisbon Council report warns.

'Delays in needed restructuring are costly: they stand to increase output losses, entail 'throwing good money after bad' ... and ultimately require a larger haircut on private claims,' Leipold writes.

He also urges EU policymakers to take a tougher line on 'stress tests' on banks, to allay market fears about their exposure to highly indebted eurozone countries, and to quickly set up mechanisms to either recapitalize or wind up weak institutions.

'It is incumbent on European regulators to proactively speed up the process - beginning with Germany's Landesbanken,' Leipold says.

'Without this, events could overtake the current slow pace and an 'unplanned' restructuring could precipitate a full-fledged banking crisis'.

Read more about Euro