European finance ministers have just come out of a mammoth series of meetings with a package of measures which will hopefully mitigate the severity of the crisis that has plagued the Eurozone countries for well over a year. As readers of The Telegraph know, the crisis surfaced in mid-2010 in Greece with its government declaring that it was in no position to repay its sovereign debt. Despite rescue packages offered by the troika of the European Commission, the International Monetary Fund and the European Central Bank during the last year, it has become increasingly clear that Greece cannot service its outstanding debt. This is despite the very severe austerity measures that were imposed on the Greek government by the troika.

The crisis worsened several times over with the sovereign debt crisis threatening to engulf Spain and Italy, two of the bigger European economies. Unlike Greece, which is at the periphery, these two countries belong to the ‘core’ of Europe and apprehensions that their economies were in trouble threatened the very survival of the single-currency system. After all, one can visualize a state of the world where the single currency system survives without Greece being a member, but it is inconceivable that the system can exist without Italy and Spain.

The crisis was further aggravated by fears that some of the European banks that were heavily exposed to the sovereign debts of Greece and other countries with weak economies might go bankrupt. In fact, a large bank — the Dexia Bank — had to be rescued from bankruptcy by means of large bailouts from the Belgian, French and Luxembourg governments.

So the European finance ministers had three crucial tasks on their to-do list. First, they had to find a way of evolving a feasible solution to the sovereign debt problem for Greece. This involved setting a target which is conceivably gettable for the Greek government — the current level of debt is so humongous that it does not provide the government with much incentive to attain targets. Second, they had to find ways of reassuring potential bond-holders that sovereign debt markets of fragile Eurozone countries like Italy and Spain would not go down the same route as the Greek one. Finally, they had to strengthen the European banking system.

A major component of the Greek solution is a huge 50 per cent haircut on Greek sovereign debt that has been agreed to by the European banks. Lest readers are wondering whether the word “haircut” is a typo, I should emphasize that a haircut is not necessarily available only from barbers. In the world of international finance, a haircut refers to a discount applied to outstanding debt, and so the 50 per cent haircut essentially means that Greece will have to pay back only half its outstanding debt. In addition, the European Union leaders have also sanctioned another bailout package of 130 billion euros to Greece. These two measures will hopefully enable the Greek government to put its debt service programme on a more tractable trajectory.

The second task is sought to be achieved by strengthening the European Financial Stability Facility. This was set up last year in order to provide loans to those Eurozone countries in financial trouble. Most observers felt that the volume of funds that had been set aside for this purpose was minuscule given the magnitude of the potential demand. The EU leaders have taken this criticism to heart by agreeing to increase the size of the funds several fold. Incidentally, it is a sign of the shift in the balance of economic power that the EU leaders are virtually pleading with China to invest in this fund.

Finally, the banking sector is sought to be strengthened by imposing a stricter capital adequacy ratio of 9 per cent. Banks have been told to raise extra capital so as to be able to reach the minimum capital threshold by June 2012. They are barred from declaring any dividends unless they reach the capital target. The good news for the banks is that they can approach their respective governments for funding if they are unable to raise the required capital on their own.

The immediate reaction around the world was a sense of euphoria, with virtually every stock exchange recording hefty gains. The initial euphoria has been replaced with a more cautious and balanced appraisal. Doubts have been raised about whether even the vastly enlarged stabilization fund is sufficient to prevent sovereign debt defaults of large countries such as Italy and Spain. Others have pointed out that the banking sector may attempt to meet the capital adequacy threshold by reducing lending rather than raising additional capital. This would surely be counter-productive since it would exacerbate the recessionary tendencies in Europe.

Ideally, the richer and stronger economies in Europe would offer guarantees, perhaps through the European Central Bank, that they will offer virtually unlimited amounts of their resources to bail out Eurozone countries in trouble. The German economy is by far the strongest in Europe. Germany has also been the leading proponent of the concept of the European ‘nation’. So, it is no surprise that Angela Merkel has been at the forefront of efforts to stave off the crisis and preserve the unity of the group. Germany has spent a significant fraction of its resources in past attempts to rescue the Greek economy, and has also been cajoling France and international financial institutions such as the IMF and the European Central Bank to supplement its own efforts.

Merkel has had to work extra hard because all stakeholders are not convinced that the benefits of preserving the single currency system exceed its costs. For instance, German taxpayers have been particularly incensed that their hard-earned money has been spent in keeping the Greek economy afloat — all the more so because these rather large sums could have been spent on reviving their own domestic economy. Similar domestic discontent — as well as the fact that its own economy is not in great shape — has induced France to oppose very large and generous bailout packages.

So the Eurozone countries and the world as a whole will have to be content with the current package. What will perhaps decide whether the single currency system can survive in its present form is the health of their economies. Most European economies are stagnant and there is real fear that they may slide back into recession. Steady growth in the rest of the world is the best possible medicine since that will improve export markets. The economy of the United States of America has just recorded better-than-expected growth in the last quarter. If this can be repeated in the next quarter along with tentative signals that the Chinese economy is also bouncing back to its accustomed growth rate, then European finance ministers can sleep better.