(Reuters) - Over the past couple of years, Europe has muddled through a long series of crunch moments in its debt crisis, but this September is shaping up as a "make-or-break" month as policymakers run desperately short of options to save the common currency.
Crisis or no crisis, many European policymakers will take their summer holidays in August. When they return, a number of crucial events, decisions and deadlines will be waiting.
"September will undoubtedly be the crunch time," one senior euro zone policymaker said.
In that month a German court makes a ruling that could neuter the new euro zone rescue fund, the anti-bailout Dutch vote in elections just as Greece tries to renegotiate its financial lifeline, and decisions need to be made on whether taxpayers suffer huge losses on state loans to Athens.
On top of that, the euro zone has to figure out how to help its next wobbling dominoes, Spain and Italy - or what do if one or both were to topple.
"In nearly 20 years of dealing with EU issues, I've never known a state of affairs like we are in now," one euro zone diplomat said this week. "It really is a very, very difficult fix and it's far from certain that we'll be able to find the right way out of it."
Since the crisis erupted in January 2010, the euro zone has had to rescue relative minnows in Greece, Ireland and Portugal as they lost the ability to fund their budget deficits and debt obligations by borrowing commercially at affordable rates.
Now two much larger economies are in the firing line and policymakers must consider ever more radical solutions.
If Spain, the euro zone's fourth biggest economy and the world's 12th, loses affordable market financing the next domino at risk of falling is Italy - the euro zone's third biggest economy and a member of the G7 group of big wealthy nations.
A bailout of Spain would probably be double those of Greece, Ireland and Portugal combined, while Italy's economy is twice as large as Spain's again.
The European Union has already agreed to lend up to 100 billion euros to rescue Spanish banks. One euro zone official said Madrid has now conceded that it might need a full bailout worth 300 billion euros from the EU and IMF if its borrowing costs remain unaffordable.
European officials have spent the past few days issuing a series of statements declaring they will act to halt the crisis.
In the latest, issued on Sunday, Chancellor Angela Merkel and Prime Minister Mario Monti "agreed that Germany and Italy would do everything to protect the euro zone".
The wording was similar to remarks by European Central Bank chief Mario Draghi last week prompted buying in financial markets on the expectation that the bank would take steps to lower the cost of borrowing of Spain and Italy.
DEFLATING LIFE RAFT
The euro zone does not seem to have enough cash in the current setup to deal with a scenario of Spain and Italy needing a rescue, and a sense of doom is growing among some policymakers. Fighting the crisis, said the euro zone diplomat, is like trying to keep a life raft above water.
"For two years we've been pumping up the life raft, taking decisions that fill it with just enough air to keep it afloat even though it has a leak," the diplomat said. "But now the leak has got so big that we can't pump air into the raft quickly enough to keep it afloat."
Compounding the problems, Greece is far behind with reforms to improve its finances and economy so it may need more time, more money and a debt reduction from euro zone governments.
If Greek debt cannot be made sustainable, the country may have to leave the euro zone, sending a shockwave across financial markets and the European economy.
September 12 is a crucial date in the European diary. On that day the German Constitutional Court is scheduled to rule on whether a treaty establishing the euro zone's permanent bailout fund, the 500 billion euro European Stability Mechanism (ESM), is compatible with the German constitution.
A positive ruling is vital, because Germany is the biggest funder of the ESM, and the euro zone would be powerless to protect Spain or Italy without the ESM.
On the same day, parliamentary elections are held in the Netherlands where popular opposition to spending any more money on bailing out spendthrift euro zone governments is strong. The Dutch vote may complicate talks on a revised second bailout for Greece, which also has to be agreed in September.
Athens wants two more years than originally planned to cut its budget deficit to below 3 percent of GDP, so as not to impose yet more spending cuts on a country which is already in a depression.
This would mean Greece's 130 billion euro second bailout package may need to be increased by 20-50 billion euros, according to estimates by some euro zone officials and economists, and there is no appetite in the euro zone to give Greece yet more extra money.
More importantly Greece needs to bring its debt, which is equal to 160 percent of its annual economic output, under control. This means euro zone governments, which own roughly two thirds of it, may need to write part of it off.
Private creditors have already suffered a huge writedown in the value of their Greek debt holdings but so far euro zone taxpayers have not lost a cent on any of the bailouts.
Reuters
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