T

he Greek drama surrounding its debt crisis is still unfolding, and it is clear by the day that the crisis is more severe than expected.

The resolution of the crisis will take several years and will be very costly and the magnitude of that cost will be beyond the financial ability of the eurozone governments.

Efforts to make decisions to resolve the crisis are facing the risk of being obstructed by policy paralysis resulting from political uncertainties that grip several euro countries.

All these were evident after eurozone leaders finished their summit on Oct. 27 in Brussels. They claimed to have crafted a “comprehensive policy” to contain the European debt crisis. But markets think the policy lacks meaningful details and leaves many questions. It reflects the daunting task of the eurozone leaders.

The problem is getting more serious as the amount of Greek debt that needs to be written off turns out to be larger than previously forecasted. In July, it was estimated that a 21 percent write down of Greek sovereign bonds would be sufficient to give some relief for the Greek government. But the Greek economy deteriorated rapidly, as austerity measures have caused a deeper recession than expected.

According to the IMF, the Greek economy will contract 5.5 percent this year and its debt will continue to rise reaching 186 percent of GDP in 2013. Its bond yield has reached a staggering 24.5 percent, a crushing debt load for the Greek government. That is the reason a 50 percent write off of Greek debt was envisaged by the European leaders during the summit. It should be implemented on a voluntary basis by investors holding Greek government bonds. If it is agreed, then it would mean a de facto default by the Greek government.

The risk is that it could lead to chaos in the credit-default swap (CDS) market that makes eurozone debt harder to insure. It could also lead to other countries having similar problems to Greece demanding the same amount of debt “hair cut”. All this would make banks more skittish in extending loans and this could stall economic recovery in Europe.

The debt crisis has hit European banks severely, as their holdings in Greek bonds have lost their value and significantly weakened their capital and their ability to lend. One Belgian bank had to be bailed out recently, while other banks with their severely weakened balance sheets would not be able to withstand bank runs and another debt default in Italy or Spain.

The agreement reached at the summit means that those banks would have to write down their Greek debt holding by 50 percent, which means a capital injection of ¤106 billion (US$146 billion) would be required by the banks for them to stay afloat. Banks are required to raise their capital ratio to 9 percent next year.

Unlike the US government that still had enough money to bail out some big banks in Wall Street during the 2008 crisis, the eurozone governments have no money to bail out banks. So the banks have to seek money from private investors, or else they have to cut dividends and bonuses.

Another tough issue for the eurozone countries is not only containing the debt crisis in Greece but also how to prevent the contagion of this debt crisis into other countries. Italy is the next worry. Its bond yield jumped from 5.7 percent to 6.1 percent last week, a level considered by the market as in the danger zone, and could exacerbate Italy’s debt burden. Italy is plagued with political uncertainties. Prime Minister Silvio Berlusconi does not appear to be a credible figure to inspire confidence in the market. Because Italy’s sovereign bond market is one of the biggest in Europe, its default would be catastrophic.

To prevent Italy defaulting means that investors must be persuaded to continue buying Italy’s sovereign bonds. To dispel worries and to inspire confidence among investors an entity called the European Financial System Facilities (EFSF) has been created to bail out governments and banks hit by the crisis. The problem is that EFSF funds of some ¤440 billion ($616 billion) are not sufficient.

A sort of financial engineering was attempted through guarantee mechanisms, whereby the fund is also used for insurance against loss in new bond issuances if there is a write down. In theory, this could “enhance” EFSF funds to ¤1 trillion ($1.4 trillion). To increase its potential funding, a special-purpose vehicle (SPV) would be created to attract funds from emerging economies, such as China and Brazil.

But it is doubtful whether China will lend a helping hand to Europe when it is facing hostility from EU governments on its exports to and investments in Europe. Why would China put their money in the EFSF when Germany and France themselves are reluctant to do the same? Besides, how could bond buyers have confidence in the guarantee by euro governments if they themselves are vulnerable to crises that hit their neighbors?

The debt crisis has strained the sanctity of the eurozone treaty and has exposed some of its flaws. Its members did not surrender their fiscal sovereignty to a supranational body, and the euro governments are unable to impose sanctions on member countries that breach the maximum limit of debt and deficits relative to GDP.

The single currency policy denies member countries any flexible policies in times of crisis. Being tied to monetary union, countries like Greece and Ireland can only improve their competitiveness through brutal and painful cost cutting. Monetary policy is exercised by the European Central Bank imposing a single interest rate within the eurozone. But there is the catch; a single interest rate by the European Central Bank impacted its member countries differently.

A low interest rate benefited such countries as Germany and France, but triggered excessive spending and inflation in Greece. There are rumors that because of the unresolved crisis Greece is thinking of leaving the European Union (EU). The eurozone will not break up of course, because the stakes are too high but many will start questioning its sustainability and viability.

A debt debacle that is more severe than expected would result in lower growth for the world economy than already forecast. This has started to impact the Indonesian economy. Indonesian exports dropped significantly in September, mainly due to a significant drop in exports to the US and EU. Between August and September, exports to the EU and the US fell by 28 percent and 15 percent, respectively.

Even our exports to ASEAN, our main export destination, also dropped by 2 percent, due to weak growth in Singapore and the floods in Thailand. As our exports continue to slow down in the coming months, it will be difficult for Indonesia to achieve its 6.4-6.5 percent growth target next year.

To compensate for the slower growth in exports the government should concentrate on policies to spur domestic consumption and investment.

The writer is an economist.