Europe and its paymaster Germany have made too much of a focus on austerity at the expense of growth, which has exacerbated the crippling situation in countries like Greece, Charles Dallara, managing director of the Institute of International Finance, told CNBC's "Squawk Box Europe".
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Bloomberg via Getty Images Charles Dallara, managing director of the Institute of International Finance (IIF). |
"We've seen the European economy within the political framework has disconnected. The overall focus on short-term budget cuts has to be adapted with economic reality," he said.
"If we can get private investors' confidence rebuilt, we can change the situation around in Greece. The focus has been too heavily placed in short-term budget cuts and this has created the feeling that the situation seems bottomless," Dallara added.
He said he was optimistic about Greece's long-term future, but said the short-term would test the resolve of the country.
"I am watching the developments in Greece carefully, but we need to allow the process to play out somewhat here. It will take some time to get results here, but when the dust settles we will have a government that comes together that has little choice but to preserve in many aspects the economic reform program," he said.
The dichotomy between austerity versus growth has grown wider in recent weeks as voices opposed to the euro zone's often harsh austerity measures have become louder across the region in recent weeks.
Added to this was the French election of socialist Francois Hollande to president, with elections both there and in Greece being seen as a stemming from a disaffected electorate lashing out against spending cuts.
Dallara said costs to the stronger European nations were "manageable" given what was at stake.
"I think Germany will have to, with other euro zone partners, re-evaluate the current economic strategy here and consider adaptations to place the euro zone economy on a more credible path," he said.
"It must rebalance the growth-austerity equation and stretch out the path of fiscal adjustment in a number of the adjusted countries." "This may take more funding over the next few years," he added, "but it is (a) much less costly approach than to let the situation to deteriorate in countries such as Greece, Portugal, Spain and Italy to the point where they run into increased difficulties." The IIF was the central private sector body involved in the successful negotiation of Greece's debt restructuring.
Greece has been placed firmly back into the crosshairs of the markets as it plunged into political turmoil following the failure of the weekend's elections to provide a decisive win for the two main political parties, New Democracy and socialist PASOK – both proponents for the country's second international bailout earlier this year.
Around two-thirds of the vote on Sunday went to parties that oppose the bailout plan.
New Democracy failed to form a coalition on Monday, and the mandate has now passed to leftist parties to form a government.
Markets reacted badly to the latest drama in the beleaguered country, with sharp sell-offs across global markets Monday, though European markets managed to claw back some losses in late trading.
Dallara said Greece needed to recapitalize its banks as a matter of urgency to kick start growth in an economy widely regarded as the sick man of Europe.
"There needs to be an urgent recapitalization of banks in Greece and I would encourage all authorities to move (...) to recapitalize the Greek banks to get credit flowing into that economy which is remarkably credit starved," he added.
"Some regulatory reform could be put on hold for a period of time so pressure to rebalance levels of capital can be eased and the credit activity can start growing again. You are not going to have renewed growth as long as you have contractions of credit," he said.
© 2012 CNBC.com
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