2012: A bad start for the Euro?
Friday 27 January 2012By Christian Meyer zu Natrup
The new year started like the old one; with bad news.
The rating agency Standard and Poor (S&P) stripped France and Austria of their tripe A rating, along with Malta, Slovenia and Slovakia who were also downgraded by one notch. Italy and Spain suffered even worse with a two notch downgrade to BBB+ and A respectively.
As expected, Portugal and Cyprus bonds have been downgraded to junk status. The only good news is that the downgrade was long expected and hardly surprising. In early December S&P has warned of possible downgrades just before the Europe’s decision makers met for yet another summit that was promised to tackle the debt crisis for good. S&P reasoned its downgrade by arguing that the summit failed to deliver.
The rating agency proclaimed that the summit had "not produced a breakthrough of sufficient size and scope to fully address the euro zone’s financial problems”. S&P’s statement did not include much specific information and instead relied on general opinions, including that EU leaders are guilty of focusing too much on reducing government’s deficit, which is only part of the problem. Consequently, S&P argues, they do not work sufficiently on the actual causes of the crisis, being the divergence in competitiveness between the euro-zone’s strong economic core and its struggling "periphery" as well as the huge cross-border debts that arise from this gap.
As such, political action based only on fiscal austerity could easily become self-defeating, argues S&P. No doubt this lecture on fundamental basics of macro-economic principles is correct, however it fails to take into account the outcomes of the 9 December summit and the positive markets reaction to it.
The December summit has succeeded to introduce some major principles about how the Euro zone will be governed in future. Firstly, and most importantly, the summit followed the German example of introducing a debt limit for all Euro zone countries of 0.5% of Gross Domestic Product (GDP).
Even more important however is that the summit also provided the European Commission with the power to police this debt limit by authorising it to conduct assessments of Euro zone members. The commission is then entitled to make recommendations to the member country and even impose a compulsive request that the member country pays 0.2% of GDP into a Commission supervised deposit account if the assessment outcomes regards the member country as approaching the 0.5% debt limit.
These nearly draconic powers represent political action previously unseen over all previous Euro-zone summit. It is therefore surprising that S&P seems to completely disregard these, particularly when considering that the Commissions powers are extended even further.
The Commission is now empowered to implement so called Excessive Deficit Procedures (EDPs) if the assessment finds that public debt exceeds the 0.5% of GDP limit.
As a first step, the EDPs call for closer monitoring of the member country, followed by the member country loosing deposit interest from its 0.2% of GDP deposit. Should this be found to be not sufficient, the EDPs go even further by imposing a fixed fine of another 0.2% of GDP up to 0.5%. Thereafter, the EDPs power become near limitless as they are able to impose “variable fines” if the member country continues to exceed the agreed debt limit.
The debt limit and the EDPs represent a deepening of the economic governance across the Eurozone and sensible regulative and governance additions that were simply forgotten upon the introduction of the Euro over ten years ago. It enables the Commission to inspect and police the Euro-zone’s economies, at least in terms of its public debt. It is therefore hard to see how S&P chooses this December summit, at which such major steps were finally agreed, to reason its downgrade.
Maybe S&P became aware of this and therefore chose Friday the 13th of January to make its announcement, possible hoping that the infamous date would lend a bit more punch to its somewhat light-weighed arguments. As unprecedented as the December summit may have been, it cannot be regarded as the saviour of the EURO.
Two more things are necessary to finally put the crisis behind us and inspire investors confidence. First, the European Stability Mechanism (ESM) needs to achieve its EUR500bn lending capacity. This is scheduled to be done by mid 2012, however the complexity and variety of sources feeding the ESM make this date hard to achieve.
The ESM is supposed to be cash-stocked through the European Financial Stabilisation Mechanism, the European Financial Stability Facility, the International Monetary Fund and Bilateral Loans. Negotiations which facility provides how much when are likely to be tough. Secondly, the debt limit of 0.5% of GDP will only be regarded as a an effective solvency declaration and safeguard by investors if the Commissions powers to police it can be automatically actioned, without yet another summit or political bickering.
The Excessive Deficit Procedures agreed in December might be far reaching, they are not however practicable yet without political agreement to do so. The “Merkozy” duo, being of course Mrs Merkel, the German chancellor, and Mr Sarkozy, the French President, are pushing to make the Excessive Deficit Procedures automatic upon a Euro-zone member breaching the 0.5% debt limit, however other Euro-zone members are unlikely to agree. This disagreement is likely to be the main focus of the next EU summit, scheduled for 30 January 2012.
There is, unfortunately, another problem. The new pact might well prevent a future crisis, however it does not seem suitable to stop the current one. Ultimately, the current crisis will only be arrested by investors and markets being convinced of the Euro-zones solvency.
Debt limits and deficit procedures may do this in future, but Brussels and EU leaders fail to address how the current amount of public debt can be bought back in line. S&P’s downgrade, despite being clumsily reasoned, managed to at least point the fingers on the markets on-going concern about the amount of sovereign debt now, not the future one. Most Eurocrats look towards the European Central Bank (ECB) to act more boldly and buy as much sovereign bonds as needed to calm the markets.
As the ECB has rightly made clear, this sort of unlimited funding for Euro-zone members will not happen. However, the ECB is already providing funds indirectly by giving ultra-cheap loans to banks that may (or may not) use it to buy government bonds. It is telling that the ECB seems to prefer giving billions of cheap money to banks without any guarantee that these banks use the funds to buy bonds instead of shoring up governments.
The crisis and the bad news are therefore continuing into 2012, despite the good steps agreed at December’s summit. S&P’s ratings do not represent the full truth; if they would then markets and Eurocrats would not have shrugged the downgrades off so easily. However, “Merkozy” & Co have still much to do in order to deepen the Euro-zones governance structure sufficiently and so help to prevent future debt crisis.
As for solving the current one, there is even more to do. The ECB cannot be held as the saviour alone; that would be unrealistic. Debt-restructuring, economic stimulus and public spending reforms continue to be the best chance to lead to a way out of the crisis, as this magazine has argued many times before.
But at least 2012 is unlikely to be a boring year: a continuing crisis, some political preventive action and the light-weight view from rating agencies promise to make it an interesting one.