Brussels - The eurozone is out of the emergency ward, but it
may face a chronic debilitating illness rather than a rapid convalescence.
The challenges confronting Europe now are to avoid
complacency, rekindle economic growth while cutting debt and prevent national
politics pulling the currency area apart.
Last week's European Union summit was the first in two years
that was not totally dominated by fire-fighting in the currency bloc's
sovereign debt crisis. The relief was audible.
"This was not - and that is an innovation - a meeting
focused on crisis management," European Commission president Jose Manuel
Barroso said. "It was a meeting focused on growth."
Three events have changed the mood and calmed financial
markets that appeared late last year to be betting on a breakup of Europe's
13-year-old single currency.
European leaders have signed a German-driven fiscal compact
treaty giving sharper teeth to their oft-disregarded budget discipline rules,
and key states such as Italy and Spain are implementing tough spending cuts and
pension and labour reforms.
Greece has averted a catastrophic default, at least for now,
securing a second international bailout and a deal with private creditors to
reduce its debt mountain to more manageable levels.
Above all, two massive injections of cheap, long-term funds
by the European Central Bank (ECB) have prevented an incipient credit crunch
that could have triggered bank collapses, bank runs or a bond market inferno
forcing Italy or Spain to the wall.
ECB president Mario Draghi is the hero of the hour for
finding a way to act as a lender of last resort to banks without breaching an
EU treaty prohibition on financing governments directly.
"It's not 100% guaranteed, but I think we are coming
out of this crisis," said French President Nicolas Sarkozy, eager to give
voters in next month's presidential election the impression that the worst is
behind them.
Such self-congratulation prompted Draghi to warn EU leaders
behind closed doors that the crisis is far from over and that the ECB has now
done its bit.
Participants quoted him as saying the bank's action had only
bought them some time to repair public finances, make credible reforms and
revive growth. If Europe did not use the respite to reform, there would be very
bad consequences.
Firewall
In the next few weeks EU countries will have to decide how
to strengthen their financial firewall, and whether to sanction Spain for
flouting agreed deficit reduction targets or allow it more time to revive
growth.
German Chancellor Angela Merkel faces a crucial decision by
the end of March on whether to allow the eurozone to combine its current
temporary and future permanent bailout funds to provide a bigger war chest in
case of emergency.
The world's major economies, notably the United States and
China, are pressing Europe to put up more money for its own defences as a
condition for raising the International Monetary Fund's (IMF's) resources to
combat fallout from the eurozone crisis.
Faced with public hostility and a growing revolt against
bailouts in her centre-right coalition, Merkel may be tempted to say there is
no need for a bigger rescue fund, which would require tricky parliamentary
approval.
German officials say lowering government bond yields too far
would only reduce pressure on countries to reform.
If Merkel were to say "Nein" and the IMF were to
be denied extra funding in April, market tensions could quickly return.
The bond market is euphoric due to Draghi's massive dose of
morphine, but it has been anaesthetised, not cured. The pain could return, for
example with another round of credit rating agency downgrades of eurozone
sovereigns.
Another complacency risk is that countries such as France,
whose borrowing costs have fallen, ease up on austerity measures in an election
year. Italy's political parties are already watering down some of the radical
liberalising reforms proposed by Prime Minister Mario Monti's government of
technocrats.
Other political pitfalls lurk in Ireland, which has a track
record of voting "No" to EU treaties and is putting the fiscal
compact to a referendum, and in Greece, which is heading for a general election
amid public fury over harsh austerity imposed by its international lenders.
The political will to steward years more of economic
hardship there is anything but certain.
Spanish test
Above all, there is the contradiction between the need to
cut debt and foster growth, without which debt is more likely to rise than
fall.
Spain is a test case with Madrid seeking more time to reduce
its deficit, which hit a far-above-forecast 8.5% of gross domestic product last
year.
The European Commission and Europe's northern deficit hawks
are determined to uphold the credibility of the new system, while Madrid is
desperate to avoid plunging the country into a Greek-style spiral of depression
through more drastic budget cuts.
With unemployment above 23% and one young person in two out
of work, Spain faces possible social unrest - a risk that also stalks Portugal,
mired in economic gloom.
A widening gap between more dynamic northern economies and
shrinking southern ones is bound to fuel political tension with a "lost
generation" facing mass unemployment in several states.
Another uncertainty factor is France, which may well elect a
Socialist president in May committed to renegotiating the fiscal compact to
make it more growth-friendly. This may be mostly about political symbolism, but
the potential for a clash with Germany is real if Francois Hollande defeats
Sarkozy.
The politics of eurozone bailouts could become more fraught
in Berlin, where Merkel's Bavarian sister party and her ailing Free Democratic
partners are flirting with Euroscepticism ahead of elections in 2013.
If Greece were to fall behind on its bailout programme
again, the pressure to cut off aid and let it default and leave the eurozone
could become overwhelming in Germany, Finland and the Netherlands - the
eurozone's last AAA-rated states.
Despite those risks, it's hard to blame European leaders for
feeling some satisfaction after two years of crisis management that drew such
widespread criticism as too little and too late.
"It is not a sin to be a little more optimistic,"
said a senior EU official who has been in the thick of all 18 summits since the
outbreak of the crisis in early 2010. "We are nearing in some way a
turning point in the eurozone crisis."
But if the euro is sailing into calmer waters, there are
still plenty of concealed rocks just below the surface.
"There is a strong possibility that the crisis is
moving from a very hot phase into a cold phase. Does that mean it is over? Not
at all. There are still lots of dangers," said Janis Emmanouilidis, senior
fellow at the European Policy Centre think-tank.