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New Greek rescue promises euro drama

Oli Scarff | Getty Images

The need for a new rescue program for Greece promises a drawn-out drama of late-night negotiations but is unlikely to trigger the sort of crisis that has threatened the breakup of the euro in the recent past.

That the collapse of the single currency is no longer an immediate danger reflects the solidity of the political bargain that saved Greece a year ago.

Then, Germany, the euro zone's paymaster, agreed to keep aiding Greece so it could stay in the euro as long as it continued to tighten its belt and implement reforms to restore competitiveness. Portugal has received a similar assurance.

(Read more: Is President Obama right about Greece?)

Yet the fact that Greece's program has veered off course so soon shows that Europe is still muddling through, a long way from defusing the threat to its flagship project from recession-plagued southern governments with excessive debts tied in a doom loop to vulnerable banks.

So although financial markets shrugged off German Finance Minister Wolfgang Schaeuble's surprise public acceptance this week that Greece will need more aid, the potential for turbulence remains, according to Lena Komileva with G Economics, a London consultancy.

"Are we looking at a scenario where the euro zone can successfully overcome the crisis and move towards a highly dynamic growth cycle supported by healthier bank balance sheets as in the US? No," she said.

(Read more: Is Greece on the right track after all?)

The looming renegotiation of rescue packages for Portugal and Cyprus as well as Greece is one obvious flashpoint.

"None of those countries is anywhere near being able to stand on its own two feet in terms of funding itself in the market," Komileva said.

The strain begins to tell

Creditors' demands have put huge strain on the governments of all three countries. The longer they are in recession and have to take orders from Brussels and Frankfurt, the closer they will come to testing the political limits of austerity.

Nevertheless, Jacob Kirkegaard with the Peterson Institute for International Economics in Washington said both sides had every incentive to persevere with the aid-for-reforms formula.

(Read more: Greece gets green light for 4 billion euro payment)

Abandoning the periphery to its fate would risk contagion that could condemn the euro, while Greece would face incalculable costs if it were to quit the single currency, starting with the collapse of its banks, capital flight and default on private-sector contracts denominated in euros.

"As bad as the Greek economy has turned out in the past four of five years, this would be a cardiac arrest," Kirkegaard said.

The troika of lenders to the periphery - the European Commission, the European Central Bank and the International Monetary Fund - is due to review Greece's program this autumn.

Fabric Montagne, an economist with Barclays in Paris, said he expected the discussions to be "protracted and difficult".

(Read more: Greece Minister: Failure to meet bailout terms not our fault)

For markets, though, the process is unlikely to be disruptive because the talks will be limited to allocating losses within the public sector, Montagne said in a recent note.

Since Greece's private bond holders were persuaded to write down most of their exposure, more than 80 percent of Greek government debt is now in the hands of official creditors.

What's more, Greece's immediate needs are relatively modest. The IMF puts its uncovered funding needs for 2014-2015 at 10.9 billion euros, a pittance next to the 240 billion euros that Athens has already received in aid.

Deceptive market calm?

Greece is counting on achieving a primary budget surplus - before interest payments - for 2013, which would entitle it to ask its euro area partners for help in bringing about a "further credible and sustainable reduction" of its debt-to-GDP ratio.

Having already secured a writedown of privately held bonds, the government of Antonis Samaras sees that the best way of following up with official debt relief is to cooperate with the troika, Kirkegaard said.

Investors realize this too. This is another reason why the talks with Greece are unlikely to be too unsettling for markets, which are already reassured by the ECB's as-yet unactivated Outright Monetary Transactions backstop bond-buying program.

(Read more: Trouble Brewing: Greek Tragedy Mark Two?)

"The markets have internalized the lesson learned by all the peripheral countries, namely that in the end the best way to achieve some sort of restructuring of official sector debt is to do their homework first," Kirkegaard said.

How that debt relief is provided - if it is ultimately needed, as the IMF and most economists believe - will be an acid test for Germany and northern creditor countries, for which write-offs are anathema.

Stretching out loans for, say, 50 years at minimal interest rates to respect the taboo against fiscal transfers would be one face-saving option.

An earlier test, with perhaps greater potential to rock the euro, looms in the shape of an asset quality review of euro zone banks ahead of the ECB's planned assumption next year of supervisory powers over the bloc's lenders.

Komileva said bank creditors and shareholders will bear the brunt of any capital shortfalls, which will be difficult to sweep under the carpet.

"This will immediately raise questions about bank recapitalization and the ability of domestic governments to carry a greater burden," she said.

Such questions will be more searching if the euro zone economy fails to build on the promise of Thursday's surveys of purchasing managers.

The euro zone badly needs a revival of strong growth to ease worries about its banks - 11.6 percent of all Spanish loans were non-performing in June - and to give it time to shore up a currency whose problems reach far beyond Greece's agonies.

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