In Germany, a realisation that rescuing Portugal may safeguard Spain

A Germany made no secret of its misgivings about bailing out Greece and Ireland last year, and its very public reluctance exacerbated the debt crises that forced both nations to seek financial help.

So it may seem surprising that Portugal's request for emergency loans last week met with relief in Berlin, and that Germans by a narrow majority actually favour providing emergency credit to western Europe's poorest nation.

After 12 months of turbulence in European financial markets, Germany has grudgingly accepted its role as saviour of the euro, a currency most Germans would happily ditch if they could return to the cherished Deutschmark. Berlin will guarantee about a quarter of the loans being extended to Portugal, which is no longer able to obtain funding at acceptable rates in the bond markets after borrowing costs on its 10-year debt surged to as high as 10 per cent.

German politicians joined the rest of the EU in welcoming Portugal's decision because it appeared to lessen the risk of the crisis spreading to Spain, a much larger economy that would be far more expensive to rescue. Spain's banks are heavily exposed to Portugal, and the bailout will ease the pressure on them. In financial markets, the impact of a Spanish plea for help is being likened to that of the collapse of Lehman Brothers in 2008 - it would make the debt crisis uncontrollable.

Why the change of heart in Berlin? After all, public pessimism in Germany about the euro is as great as ever. According to a survey conducted this month by TNS Emnid, a leading polling institute, 90 per cent of Germans expect that more EU countries will need bailouts, and 58 per cent are worried about the stability of the euro. The answer is that such fears pose less of a political threat to Angela Merkel, the chancellor, than they did last year. Ever since the nuclear crisis in Japan began last month, German politics has been dominated by a debate over nuclear power that has thrown Mrs Merkel's government off course and seriously dented its popularity. The euro crisis has been put on a back burner, not least because the currency has been rising sharply against the dollar on expectations of interest rate increases by the European Central Bank.

In addition, public attention has been distracted by the war in Libya, the uprisings in the Arab world and surging oil prices. In financial markets, the yawning US budget deficit has been a focus. Also, Germans seem to have realised at last that they are far better off than most of their European neighbours.

The country is in its second year of strong growth, thanks in part to booming exports to China, and its budget deficit is set to fall below the EU ceiling of 3 per cent of GDP without the painful austerity measures that high-debt nations are enduring.

Wolfgang Schaeuble, the German finance minister, recently reiterated Berlin's tough stance on high-debt nations by insisting that Portugal would need to impose stringent budget cuts to qualify for EU aid.

But officials in Berlin have registered that the constant finger-wagging is not working. The relentless criticism of nations that fail to live up to Teutonic standards of fiscal discipline has annoyed EU partners and evidently failed to reassure the German public that Berlin can keep the euro safe. Behind the tough rhetoric, Germany agrees with policymakers in other EU states that the rescue terms imposed on Greece and Ireland were too harsh and put their economies under serious long-term strain. A year of fire-fighting has produced meagre results. Europe has managed to keep a lid on the debt crisis but has failed to start nursing the stricken countries back to health. Officials across the EU realise that a new approach is needed.

Portugal can now hope for more lenient conditions on its bailout than Greece and Ireland got. And there is growing acceptance that Greece will eventually need to restructure its debts. After a year of cutbacks, redundancies, strikes and riots, Greece remains in dire straits.

The economy is shrinking, and yields on the country's 10-year debt are close to 15 per cent - a clear sign that markets have no faith in the international rescue measures. At this point, it seems utopian to expect, as the rescue plan for Greece envisages, that the country will be able to cover its financing needs from the markets again from next year. As a result, there is growing speculation that the only solution may be for Greece to restructure its debts, by extending the maturities of bonds, lowering their coupon payments or even seeking a "haircut" - a cut in the debt principal to be repaid.

Such measures would hit European banks but might prove to be the only way to stabilise the Greek economy and budget. Mrs Merkel, worn down by a roller coaster year of crisis management and preoccupied with domestic problems, would be unlikely to stand in the way of such a restructuring. She knows it would be foolish to resist any move that could safeguard the euro.


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