The last summit?
European leaders convened for yet another summit deciding on the fate of the euro area. So are all central parts of a solution now defined? At the summit, leaders agreed on tougher and more biting fiscal rules, which are to be mostly implemented at a national level. This will help to increase fiscal discipline. In […]
European leaders convened for yet another summit deciding on the fate of the euro area. So are all central parts of a solution now defined?
At the summit, leaders agreed on tougher and more biting fiscal rules, which are to be mostly implemented at a national level. This will help to increase fiscal discipline. In fact, national fiscal rules have been shown to have significant and sizeable effects on fiscal outcomes and this effect does not just depict the preferences of society for fiscal discipline. There are also good reasons to believe that national fiscal rules will be more helpful than the European rules as they directly influence the decision making process at a national level from within – after all fiscal sovereignty remains national.
In exchange, more money has been put on the table. This includes 200 bn euros for the IMF but also an advancing of the ESM. The euro area should by now be equipped with significant money. Even without leveraging, up to 700 bn euros could be available to help countries with liquidity problems. The assumption is that money would be spent as currently in the program countries by basically taking the country from the market. This would give around 2 years time for Italy or a bit more than 1 year for Italy and Spain. Alternative possibilities of using funds to provide budget assistance or even recapitalize banks have been dismissed.
In addition, leaders re-affirmed their promise that Greece would remain a unique case and no other country would impose losses on investors. Private sector involvement is thus ruled out but collective action clauses (CAC) remain. The new system applying to new debt issued will thus be rules-based with the potential to restructure debt according to defined CAC.
Markets have, however, remained unimpressed. An Italian government bond auction of 1 year bonds on Monday sold at an interest rate of almost 6%. If such a rate was to persist for a long time, it would impose a heavy burden on Italian public finances and may even endanger solvency. So what is missing and why is the solution of the summit not yet satisfactory? I identify at least three factors.
First, the summit did not produce a credible strategy of how to generate growth. Without significantly higher economic growth in southern Europe, debt dynamics in combination with price adjustment needs will jeopardize sustainability. Even if the political system is fully determined to honour all debt obligations, rising unemployment and weak growth will undermine political stability. Europe’s south is to different degrees in a growth emergency of weak education performance, poor governance, high debt and low competitiveness. Failure to address this at regional, national and European level will prove harmful.
Second, the summit remains silent on the fragility of the banking system. The integrated euro area banking system needs an integrated and powerful banking supervision and resolution authority backed by enough means to prevent bank runs. The current system centered on national supervisors and national fiscal resources is clearly fragile and bank runs have started in a number of countries. While the ECB is stepping up its involvement as a liquidity provider to banks, ultimately more capital may be needed. The heads of state and government have yet failed to convince markets that they are willing to identify those banks in serious trouble and provide them with the capital needed. Banks are therefore very cautious in their credit provisioning and this is a drag on growth.
Third, increased reliance on the IMF means that a larger part of the assistance will be given with a preferred creditor status. More IMF involvement is in principle welcome as an outside institution may be a more neutral counterpart giving assistance but also imposing conditionality. However, as the IMF – in contrast to the ESM – has a preferred creditor status, access to markets after the program may be more difficult. Alternative options to use funds, for example by providing direct budget assistance and thereby keeping the country in the market, have not been endorsed. Also the fact that all new debt after the ESM is in place is issued with CACs will put them at a disadvantage to the existing debt stock and may increase financing costs.
Finally, there remains a significant implementation risk of the decided measures. Details will have to be worked out. National parliaments will have to agree on the measures decided and additional funds from third countries will need to be raised for the IMF resulting in potentially long-lasting discussions about the governance of the IMF.
Going forward, the eurozone may ultimately need a true supranational authority, which can provide for more guidance and support in generating growth, which can supervise and ensure banks and which can provide different forms of assistance to member states. Until such a political union with a clear executive (that could ultimately provide for a stability anchor backing common bonds) exists, more summits are to be expected. The last summit is but one step on a long road.
Guntram B. Wolff is co-author of “What kind of fiscal union?”
A version of this column was also published in Eurointelligence and El Pais
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