A concerted effort by the G20 this week focused on how to stem the tide of recession. But one can never forget that, earlier this year, the EU leaders had also worked hard on a possible solution for the sovereign debt crisis and quietly announced a plan that was hailed as a breakthrough, which sadly, in the past months, has not completely calmed the waters. True it was a brave effort reached after tough negotiations led by Angela Merkel and in essence it was a three-pronged affair.

The first step was a 50 per cent haircut by banks followed by the second step of leveraging the EFSF to reach one trillion euro and a final step involving an aggressive evaluation of banks immediate recapitalisation to meet any future shocks. One may well ask whether the medicine will cure the patient.

“Not so easy,” says Thomas from Insight Investment Management, “the recession in Europe is going to happen, and if the ECB does what it should and aggressively eases policy, there should be a weaker euro next year. But to start with, can anyone be complacent when contemplating the break-up of the euro experiment which allowed partners such as Greece to borrow till the cows came home in a bid to finance its profligacy.”

Brussels is now shocked to discover the debt mountain accumulated by the Athenians which in the past years nobody raised eyebrows when European banks happily financed its creation.

Faced with unprecedented unemployment and deteriorating finances, Greece is being blamed by economists for having narrowed Europe’s room for manoeuvre in battling the contagion, which threatens to pitch the country into default, shake its banking system, infect Spain and Italy and tip the world economy into recession.

To comment on the situation on our own turf, we have registered a mild recession in the first quarter of this year amid fears that this year’s tourist season performance is expected to reflect badly on the industry. Equally cautious was Prime Minister Gonzi in his assessment when he emphasised the seriousness of the current situation in the eurozone.

Addressing journalists in Brussels, Dr Gonzi said that so far it does not appear that Maltese banks need an injection of fresh capital, adding that the country’s banking system is considered ‘very robust’ with exemplary strong balance sheets. Not so lucky was Dexia: a Belgian bank which last year faced severe difficulties and had to be bailed out by its sovereign shareholders. Last month in Spain, the fourth largest bank, Bankia, needed a €19 billion capital injection by the State to stabilise its balance sheet. Does this volatility bode well for the stability of the euro in its medium term growth prospects? A wise answer was recently given by Mr Barroso in Brussels who said that “together we swim, divided we sink”.

He warns heads of government to toe the line. With courage and determination the troika (ECB, IMF, ESEF) is expected to reach agreement on boosting long-term growth. The recipe or cure for growth heralds enhancing measures, which include exploiting the single market, reducing the administrative burden and reducing the overall regulatory burden, among others.

Is this wishful thinking? How many times have we heard the mantra of killing bureaucracy (when Brussels itself wallows in it)? How can the group of 17 eurozone members that have disparate economic performance and with varying rates of taxation ever converge to prescribed Maastricht criteria unless a fiscal union is put in place? Empirical studies reveal how a serious lack of central monitoring in Brussels has resulted in countries straying away from the requirements of the Stability and Growth Pact, unconsciously undermining their own position and that of the eurozone. Now that the crisis is eating into the credibility and survival chances of the single currency, all concur that it is opportune to improve the policing of the new fiscal pact piloted by Merkel and Sarkozy.

This pact now empowers Brussels to monitor and finally approve annual budgets before presented in respective parliaments. Sceptics feel this is not a permanent solution but rather a case of shutting the stable door after the horse has bolted. What is being witnessed at present is that laggards such as Greece, Ireland et al are being rescued from bankruptcy by digging deep in the pockets of other members who were more faithful to their obligations.

The Fiscal Pact now mandates that the shaky Stability Pact should be effectively enforced because it is beneficial for everyone that deficits stay below 3 per cent of GDP or, better still, are in surplus. Critics of a policy to tighten the screws and impose austerity measures especially during a recession, say it is ambivalent to chastise rebel countries who strayed from the agreed norms or to plead for stronger mechanism for the European Commission by effectively cutting pensions and impose job cuts.

Again what is good for the goose is also good for the gander. Ironically, history shows us that when Germany and France exceeded official limits the goal posts were conveniently moved and they were not expected to pay fines or launch any austerity measures. So what is the best solution to salvage the euro and avoid the collapse of the banking dynasty in Europe? It is not an easy question to answer.

Purists wanted to see a stronger European Union, politically and economically, while respecting the individual country’s sovereignty, but nobody wants austerity measures in their back yard. Typically, all countries scrupulously fight for their sovereign right to exercise domestic fiscal policies.

Some (like Malta, UK, Ireland) are against fiscal federalism, and came out rejecting the introduction of a common consolidating tax base (CCCTB) and the imposition of pan-European financial transaction tax. But in the absence of a union of homogenous countries with compatible economic growth now faced with a deep recession, the solution surely lies in creating a huge EFSF mechanism that serves to cushion all potential bailouts and calm the markets.

Ironically, if Italy goes under with its massive €1.9 trillion debt, the ESSF fund needed to bail it out is too huge. Perhaps a temporary solution is to leverage the funds via IMF resources. Now we are told that, subject to ratification, the European Financial Stability Facility (EFSF) rescue fund be leveraged to more than €1 trillion. This move is still not popular with the EU paymaster, that is, Germany, which faces internal problems with its electorate.

Kathleen Brooks, research director at Forex.com in London said, “The biggest challenge for the German Chancellor is to persuade the German Bundestag to agree to the changes to the EFSF.” Merkel is once more in the limelight regarding deliberations on how best to stamp out the crisis that came to light two years ago in Greece. Under the terms of an agreement struck with her coalition, she must seek parliamentary backing for any changes to the rescue fund that carries budget implications for Germany.

As stated earlier, at the recent summit leaders insisted that banks undergo substantial recapitalisation to cushion any toxic debts in their Balance Sheets. So apart from the leverage of EFSF, there is a cost of new capital to prop up banks and help them get rid of potential impaired Greek bonds. This is no walk in the park, especially with governments now urging financial institutions to write off losses of 50 per cent on their Greek debt.

And yet markets are still sceptical, saying that such measures are purely cosmetic. The Greek electorate, in a cliffhanger election, voted for a pro- bailout government last Sunday. Still why are markets so jittery when the patient in sick bay is taking its medicine via austerity measures and is getting the best medical attention? This is because the real problem is not Greece, which only constitutes a small part of the European markets but Spain, and Italy.

Ironically, the big fear is “contagion” - that a Greek default could trigger a financial catastrophe for other, much bigger economies such as Italy. Quoting Angela Merkel, “Italy has great economic strength, but Italy also has a very high level of debt that has to be reduced in a credible way in the years ahead.”

As with Greece, eurozone leaders (with the exception of French president Hollande) believe the solution for Italy is more government austerity − spending cuts and tax rises. It is no surprise that Italian government’s debt, at 118 per cent of GDP is certainly high, even by European standards.

Moreover, the large debts of the Italian government are nothing new. It has lived with the problem of a debt ratio exceeding 100 per cent of its GDP ever since 1991.Really and truly the problem is the heavy yoke to meet the principal and high interest payments on its existing debts. To add salt to the wound the Italian economy is stagnating. It is common knowledge that its bureaucracy is rampant, it is plagued by poor regulation, vested business interests, an ageing population, and weak investment, all of which have conspired to limit the country’s ability to increase production. In short the outlook is grim for Spaghetti lovers.

Italy is uncompetitive which resulted in years of weak growth, as Italian workers find their pay is frozen, or even cut, but it has a long way to reach the competitive levels that they can claim to regain a price advantage over other EU economies. Under the Monti (an unelected technocrat) government, more austerity means more public spending cuts that hurt the economy even more. It is a vicious circle. That means the market’s loss of confidence in Italy and the recent downgrading by credit rating agencies could well end up becoming a self-fulfilling prophecy.

If markets panic, and switch their money out of Italian debt into “safe” German debt, Italy is expected to pay seven per cent interest rates on bonds. It would need an enormous bailout that would over run the eurozone’s current EFSF.

To conclude, one cannot ignore the warning issued by Mario Draghi an Italian central banker who recently assumed the presidency of the ECB.

He said in a speech in Frankfurt that there could be no economic growth or financial stability in Europe without “fiscal discipline.” Coming from an experienced banker, it is a stark reality check when one recalls how the ECB cut its growth forecasts for 2012.

The economic barometer is pointing to a harsh summer ahead of us.

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The writer is a partner

in PKF an audit and

business advisory firm.