Editor’s note: As investors scramble to keep abreast of latest tumultuous developments in debt-laden Greece, Lorne Baring at B Capital, a boutique private bank with offices in Geneva and London, explains the issues at stake.

On Thursday last week the European Union leaders announced that they had agreed a plan to solve the sovereign debt crisis in Europe. The details of how the agreed bail-out will be paid for and whether banks will really volunteer to forgo receiving their insurance payouts is still unknown.

B Capital believes that the success of this latest EU summit is not to be judged in the days after the announcement but rather in the weeks and months to come, however, there is the possibility that financial markets have been substantially damaged already by the political delays and that confidence in the solution will erode.

Have the EU leaders finally realised the seriousness of the situation?

The assumption we have taken from last week’s meeting is that the majority of the EU leaders have finally grasped the seriousness of the crisis albeit long after markets and external commentators (including other Group of Seven nations) did so. The EU governments are going to do whatever it takes to save the euro from falling apart and are only now getting that message across. The delay in reaching this point has made the task both heavier and more complex.

What conclusions have you come to following the announcement of the rescue plans?

Firstly, the execution of the grand plan will be hard to implement quickly and effectively as arguments re-surface between the seventeen member countries. If Greece is forgiven 50 per cent of its debt burden how will other over-indebted but harder-working countries react? A more prudent nation that is implementing tough austerity measures and structural reforms to reduce the debt to gross domestic product ratio might feel that Greek neighbours are being favoured unfairly. It is likely that divisions will open once the detail of the plans are worked through and the result of this may be a dangerous stalemate that has been the hallmark of the EU debt crisis so far.

The second conclusion is that the plan has taken too long to arrive and as such the damage within the weakest economies is now much greater to the extent that Greece (as the smallest but most severely affected country) will not be able to grow its way out of debt unless the haircuts are even larger. The eurozone debt problem can only be solved in the long term when Europe is structurally more competitive, fiscally unified at a federal level and able to bring spending under control. I believe that the summit last week was almost two years late in coming and whilst corporate balance sheets were being restructured effectively, the EU government leaders were asleep at the wheel.

Is Greece the real issue here or should we be more concerned about Italy?

Greece is the EU canary in the coalmine and has had more attention than warrants such a small contributor to European GDP. The real focus must be on Italy and its substantial debt burden. The market measure of confidence in the ability of the EU leaders to act in time might be derived from the yield on the Italian 10-year treasury bond (BTP) as Italy is the largest of the southern European debtor nations, with a debt to GDP ratio of 121 per cent.

Whilst equity markets experience volatile mood swings, it is the debt capital markets that provide a more clinical overview of each country’s health. The 10-year BTP has been climbing towards the 6.0 per cent yield level through the last quarter and despite the announcements of last week, the borrowing costs continue to mount. It has now passed 6.25 per cent, which is widely believed to be unsustainably high. This is an indication of the scepticism that the plan is not enough. In our view the size of the package will need to be larger and is in need of greater international support, including substantial commitments from the US and China, which is thought to be likely via the IMF but will still need negotiation mainly with China who will demand a greater share of IMF voting rights.

What is your strategy in light of the recent events?

With the recent news that Greece is now going to have a referendum on the bail-out measures, the execution of last week’s plan looks already set to be a mess. Our strategy in this period is unchanged as we wait to see if the macro risk from Europe will continue to threaten fundamental valuations once again. We favour higher levels of cash and remain underweight on equities until more information about the European situation indicates that the required restructuring is under way.