Eurozone leaders have agreed on how to resolve debt crises from 2013, but failed to reassure markets about what they will do in the short-term, sticking to what the IMF has called a piecemeal approach to the crisis.
At a two-day summit, leaders agreed on a change to the EU treaty to create the European Stability Mechanism (ESM) — a permanent financial safety net from 2013 — that will help countries with liquidity problems and allow for debt restructuring of insolvent ones.
But market concerns are focused on whether the eurozone has sufficient immediate funds to come to the aid of the likes of Portugal or Spain, should they need a bailout next year.
"The new ESM should safeguard the eurozone's financial stability in the future. However, it is to some extent window-dressing as it does not solve the current crisis," said Carsten Brzeski, senior economist at ING bank.
The eurozone's current fund — the European Financial Stability Facility (EFSF) — can borrow on the markets backed by eurozone government guarantees and has up to 440 billion euros ($583.29 billion)
to lend to governments cut off from market financing.
But many economists believe that even though only a small part of the EFSF's funds have been used to help Ireland, it may turn out to be insufficient if more countries need help.
"European leaders failed to address the issue of debt sustainability and possible insolvency problems prior to 2013. Debt restructuring, a common eurozone bond or an increase of the EFSF? None of these issues have been addressed. But they have to be," Brzeski said.
European Union President Herman van Rompuy said there was no need to talk about increasing the EFSF now, but if such a need arose in the future, eurozone leaders would do whatever was necessary to ensure the stability of the eurozone.
Economists said such declarations were not enough.
"The statement is full of assertions proclaiming the unity of the EU and the success of the measures taken so far to deal with the crisis ... but there is little in the way of specifics," said Ken Wattret, chief eurozone economist at BNP Paribas.
European leaders have used the same phrase since May, when they created the EFSF, but this did not prevent markets from forcing Ireland to ask for EU help and from Portuguese and Spanish bond yields being driven to record highs.
While a pre-Christmas market lull may have led to a temporary truce in the onslaught against peripheral eurozone debt, ratings agencies have been busy flagging up the fact that risks are undiminished.
Moody's slashed Ireland's credit rating by five notches on Friday, having said on Thursday it may downgrade Greece. It delivered the same warning to Spain on Wednesday, although it said it did not expect Madrid to have to resort to a bailout as Greece and Ireland have.
Rival agency Standard & Poor's said this week it may cut Belgium's debt rating if the country's inability to form a government threatened deficit- and debt-reduction goals.
A MISSED OPPORTUNITY
"We believe financial markets are likely to be disappointed by ... the overall silence regarding other proposals made in the run-up to the summit, such as the upsizing of the EFSF and E-bonds," said Frank Engels, economist at Barclays Capital.
"The preliminary outcome of the EU summit ... represents yet another missed opportunity by European policymakers to forcefully address investor concerns and calm markets in a more sustainable and pre-emptive manner," Engels said.
The EU method of responding to new developments in the debt crisis only when they appear, rather than getting ahead of the curve, is seen by the IMF as one of Europe's main shortcomings.
"I am worried, and that's why I am urging the Europeans ... to provide a comprehensive solution because this piecemeal approach ... obviously doesn't work," IMF head Dominique Strauss-Kahn told Reuters on Thursday. "The markets are just waiting for what's next."
Policymakers have been informally discussing various options from boosting the effective lending capacity of the EFSF through tweaking its operating criteria, to doubling its total size.
Further informal ideas include higher lending to the IMF to increase its involvement in eurozone rescue plans and extending stand-by credit lines by the EFSF to governments whose borrowing costs are rising, but which are not yet cut off form markets.
Some in the eurozone back the idea of a common eurozone bond but Germany has publicly opposed the idea and is against increasing the size of the EFSF as both moves would be difficult to sell to German voters angry at bailouts.
"Germany's rejection of the expansion is another example of how eurozone governments do not agree on the best way forward to deal with this crisis," said BNP Paribas' Wattret.
"As a result, the measures taken have been piecemeal, unconvincing and reactive rather than pre-emptive. This is going to have to change if confidence is to be restored in a lasting way," he said.
Economists also said the leaders' decision to conduct new stress tests of eurozone banks, to help restore confidence in the financial sector, was undermined by the lack of credibility of the last such exercise in July.
"Given the erosion of credibility of the first stress test results following the problems that emerged at Irish banks thereafter even though these banks had successfully passed the stress tests, we believe this news will not have any notable market impact for the time being," said Barclays Engels.
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