(COURTESY OF VANESSA ROSSI)

Since the news from Greece of an unexpectedly large surge in its government deficit and debt broke at the end of 2009, there has been an escalating crisis at the heart of Europe. However, despite various rounds of talks in Brussels and Washington while the Greek Government struggled to maintain the country's financial stability, no concrete measures were forthcoming until the situation reached a breaking point in late April. Following the downgrading of Greek debt to junk (below investment grade) by the credit ratings agencies, with Greece on the verge of default, euro zone members finally accepted the need to provide assistance, agreeing to a three-year, 110-billion-euro joint IMF (International Monetary Fund)-euro zone package on May 2. By then, what started out in January as a typical IMF bailout for a country in financial distress had turned into a serious crisis of confidence for the whole euro zone, inflating the scale of the bailout package that had to be put on the table.

Unfortunately, the May 2 bailout was never going to be a convincing solution to Greece's dilemma. Indeed, the IMF's own projections pointed out that Greece would face even higher debt of around 150 percent of GDP by 2012—possibly much higher still if, as seems quite likely, the actual outcome after three years were to turn out less favorable than the IMF assumptions (e.g. lower economic growth and less reduction in deficit spending). Analysts sensibly concluded that the package simply delayed default or restructuring rather than offering a full resolution of the debt problem. The supportable level of debt for Greece, which largely borrows from abroad, is probably about 90-100 percent of GDP at most—implying that as much as one third of Greek debt may have to be written off. This would be about the same sum as the proposed aid package—around 110 billion euros by 2012.

There is also no doubt that this bailout is deeply unpopular, not just in Germany but also in countries much poorer than Greece, such as Slovakia and Slovenia, which may now be obliged to help fund Greek debt. The political leadership of Europe cannot simply ignore such voter opinion, especially in countries about to face elections, as Germany rapidly discovered from the government's loss of votes in a state election in mid-May.

Voters are rightly dismayed at the laxity shown. The Maastricht Treaty required a government's debt to be no more than 60 percent of GDP, yet Greece exceeded 100 percent of GDP some years ago and now has a public sector debt/GDP ratio rapidly approaching 150 percent. And Greece was not the only culprit in breaking the rules.

If nothing else, the episode has shown that the euro zone has to radically improve its governance if it is to survive in its present form. It also revealed that there was no plan in place to deal with any such crisis—a misplaced optimism based on the view that member states would abide by the euro zone rules, which mainly focus on keeping public sector finances in good order, within the prudent guidelines stipulated.

Lack of emergency planning meant that when swift policy action was most needed, the main protagonists were left struggling to formulate how any policy response would work and whether it was constitutional, adding to the confusion. This was not the fault of financial markets and speculators.

Tougher policing is expected, probably led by the country that will have to pay the biggest bills, Germany. But this only imposes penalties and budget discipline. Will macroeconomic oversight become any smarter and can it deliver a better economic performance?