EU Summit Dec 8-9th: Kicking the Can Some More
December 12, 2011 3 Comments
At the very best, the recent EU summit served to do what eurozone leaders do best: buy time. But as with the last summit, what was announced was as important in some ways as what wasn’t announced: a number of details were not agreed and the ECB did not respond with an announcement that it would step in to support peripheral countries in the markets as a lender of last resort (LOLR).
To stem the immediate crisis, it was agreed that national central banks (NCBs) would provide bilateral loans to the IMF. At least some of that funding, together with unearmarked money in the EFSF/ESM and bond purchases from the ECB, will comprise a bailout package for Italy and Spain. This could take Italy and Spain out of the bond markets through mid-2013. By that point, the governments in both countries will have implemented strict austerity, which will undermine growth and render their fiscal dynamics even worse. With no more cash for a bailout, Italy and Spain will face a debt restructuring.
To address the fundamental structural imbalances in the EZ, treaty changes were agreed among most EU member states, with the UK opting out of the treaty changes. The reforms mooted involved countries introducing a golden rule into legislation to ensure the budget is roughly balanced over the business cycle and that public debt does not exceed 60% of GDP. Sanctions for countries that miss their targets will be imposed unless 85% of the votes oppose it. This essentially amounts to a souped up Stability and Growth Pact, which does little to address the political or financial aspects of the eurozone crisis. Instead, it institutionalizes the asymmetrical adjustment in the eurozone, whereby peripheral countries retrench to undergo internal devaluation and core countries do very little to adjust their current account imbalances. This ensures that growth will be elusive in the region over the next few years.
What was missing
The measures announced could buy some time at the very best, but they might also fall flat. A number of questions must be answered to determine how effective the measures might be:
- Will an IMF programme be used to take Italy and Spain out of the markets entirely or just to support them in the markets (as is Germany’s preference)?
- Will other countries such as the U.S. and the BRICs match the increase in contribution from EZ NCBs?
- How much of the €200 billion lent by NCBs will be earmarked for the EZ specifically, as the Bundesbank is insistent that not all of the NCB contributions be distributed to the region if the spirit of the treaty is to be upheld?
- The ESM will involve PSI “in accordance with IMF guidelines,” but what are these guidelines?
- Will the Socialists in Finland accept an ESM with no forced private sector involvement (PSI)?
- With the UK opting out of the fiscal compact, how will the treaty change occur?
- If the treaty changes are done outside of the EU treaty, how will it be enforced (a treaty within a treaty will not have recourse to EU resources)?
- Will a referendum on the treaty changes be required in Ireland?
- Will Finland back down from its position that the fiscal compact is unconstitutional as long as a qualified majority of votes is required to block, rather than unanimity?
Also missing after the summit was an announcement from the ECB to indicate its willingness to become a lender of last resort. After the December ECB governing council meeting, ECB president Mario Draghi indicated the central bank would not play a greater role in alleviating the crisis even if EU leaders agreed a fiscal compact. Many investors hoped that this was just posturing to maintain pressure on politicians to find agreement at the EU summit. We will have to wait until next week to know how much peripheral sovereign debt the ECB bought in the markets following the EU summit, but sharply rising bond yields in Italy and Spain today indicate that the central bank hasn’t been buying bonds in drastic quantities. In any case the ECB has clearly continued to resist becoming a lender of last resort.
Eurozone leaders have bought themselves a little time with the reforms they agreed at the EU summit, but they have not drawn a line under the crisis by any means. I doubt any market rally will be long lived–indeed investors gave the EU summit results a lukewarm reception and Italian ten year bond yields in particular had soared back up to around 7% by the end of the day on Monday. This is by no means the last EU summit to save the eurozone that will be promised. The only question is how quickly investors will force the next one.
For more analysis on the EU Summit Dec 8-9th and view on the future of the eurozone, see EU Summit: Can Successfully Kicked, but No One Too Impressed by Roubini Global Economics.