The Sisyphean Task of Managing the Euro Zone

Credit: - Photo: 2011

The Sisyphean Task of Managing the Euro Zone

By Peter Wahl*
IDN-InDepth NewsAnalysis

BERLIN (IDN) – In spring 2011 it became more and more obvious that Greece would not be able to comply with the conditionality of the 2010 rescue package of €120 billion. Targets were not reached since the budget cuts and austerity measures had stalled growth, and the recession was deeper than calculated. Spending for unemployment went up while tax revenues fell.

Also progress in privatisation was sluggish. As a consequence, interest rates for Greek bonds went up again and speculation with credit default swaps revived. The report of the ‘Troika’ – the surveillance committee for the implementation of the rescue package, composed of the EU Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) – on June 8, 2011 made the failure of the first official programme.

Therefore, the EU-Council meeting of heads of state decided on July 21, 2011 to release a second financial rescue package, which amounts to €109 billion. The package is not a grant, but a loan, which will be reimbursed through the European Financial Stability Facility (EFSF) that  was established in May 2010.

The interest rates of the loans in the new package have been lowered from 5% to 3.5%. The maturity, that is, the end date of the loans, has been extended from currently 7.5 years to a minimum of 15 years and maximum of 30 years with a grace period of 10 years. These interest rates  and maturities  for Greece will also apply for loans to Portugal and Ireland.

How Much Will the Banks Contribute?

The participation of the finance industry in the rescue has been heavily pushed by the German government. France was initially opposed to it, because French banks hold a large number of Greek assets. For long there has been a fear that non-repayment of Greek bonds would bring down banks who are holding many Greek bonds, especially banks in Germany, France and the U.S.

The involvement of the private sector is a new element. It is only on a “voluntary basis” and through a menu of options:

1. Bonds can be changed at face value to bonds with a maturity of 30 years and an interest rate of 4.5% on average. It is guaranteed that the bonds are paid back after the 30 years.

2. Investors can keep their bonds until the initial date of maturity, but have a guarantee to get their money back. This option does not contain a “haircut”, implying a reduction in the value of the bonds.

3. Bonds can be changed at 80% of the face value with a maturity of 30 years. In this case the interest rate is 6.42%.

4. The bonds can be changed at 80% of the face value with a maturity of 15 years. The interest rate is 5.9%. However, only 80% pay back is guaranteed after 15 years.

The contribution of the private sector is estimated at €37 billion for the period 2011-2014, which corresponds to a “haircut” of approx. 25%. Given that the present market value of Greek bonds is at 50% of the nominal price, this is a good deal for the private sector. In addition, a debt buy-back programme could contribute to €12.6 billion, bringing the total of the private sector contribution to €50 bn. For the period 2011-2019, the total net contribution of the private sector involvement is estimated at €106 bn.

Will the New Rescue Package Work?

The rescue package is, like its predecessor, tied to strict conditionality, such as privatisation of public property (over €50 billion), tax increase and reforms of the tax system, cuts in the budget, austerity measures and measures to increase competitiveness.

However, in the meantime, the Greek government has had to admit that it will not be able to meet the requirements for 2011. The decisive reason is that the austerity measures tied to the first rescue package have led to a deepening of the recession. Whereas the Greek economy was shrinking by 2.3% in 2009, the shrinking rate for 2010 was 4.3% and the latest forecasts for 2011 speak of 5.3%. Under these circumstances it is clear that it will not be possible for Greece to recover. Additional austerity policies and budget cuts only increase the problems and move towards financial, economic and social disaster.

In addition, the disbursement of the new package is questioned since the conditions of the previous programme were not fulfilled. The Troika left Greece in anger in August 2011 and will make a new assessment by the end of September 2011. Other problems with the new rescue package are:

– As the private sector participation is voluntary, it is unsure whether the expectations will be fulfilled.

– Some member countries of the Euro zone hesitate to contribute to the rescue package, for instance Slovakia. The Slovak parliament will decide only in December 2011. This increases uncertainty and might trigger additional speculation.

– Finland wants, under pressure of the right-wing populist party, a bilateral guarantee for its contribution. Otherwise the country would not participate in the rescue package.

– Also in Germany the voices that expect a default of Greece and consider making the country leave the Euro, are becoming louder and louder – among them, the minister of economy and vice-chancellor Philipp Rösler. Angela Merkel still excludes this option and there might be a good deal of domestic interests and psychological warfare vis à vis Greece. But the taboo on extreme options has been lifted.

Mid-September 2011, the situation was still open with dramatic turns every day, politicians making hectic statements, holding meetings and taking emergency actions to “calm the markets.” Obviously the political decision makers, not only in Greece, seem to have lost control over the situation. At the same time, “the markets” require political leaders to take resolute decisions. The European crisis management seems to be at the brink of failure while big challenges are still awaiting, such as new governmental debt repayment obligations in 2012 by Italy and Spain.

While trying to not further “upset the markets”, the European Parliament and Council finally came to an agreement on September 15, 2011 on the so-called “Six Pack” of legislative measures that would allow the European Commission to keep budget deficits in check with somewhat less autonomous powers. The decision on the Six Pack is expected to become final with a vote at the plenary of the European Parliament at the end of September 2011.

The ‘Debt Brake’

A French-German summit on August 16 further developed the concept of economic governance which aims at solving the debt and Euro crises in the medium term and preventing new ones. In a joint letter to the president of the European Council, Herman van Rompuy, Nicolas Sarkozy and Merkel outlined the consensus they reached at the bilateral summit on the economic governance of the Euro zone.

Most principles had been spelt out already in the months before, but its core element – the establishment of a ceiling for public debt, called the “debt brake” by the Germans and “the golden rule” by the French – has been made concrete: Based on the figures from the Maastricht Treaty, the limit for public debt is set at 60% of GDP, and the public deficit at 3%. The rule should be anchored in the constitution of each country in the Euro zone by summer 2012. This should have binding power also in the long run and make the decision irreversible, irrespective of who or which party will be in government in the future.

Germany introduced its own “debt brake” in 2009 already. Spain has also decided to amend its constitution and Italy has announced plans to do the same. The final goal of the project is to have “balanced budgets in the medium term”. In order to strengthen budgetary discipline, the structural funds of the EU should be used as an instrument of enforcement. They should be targeted at improving competiveness and reduction of imbalances in the Member States. The European Commission should automatically control that the funds provide the optimum support for the macroeconomic adjustment programme.

Sarkozy and Merkel also proposed regular meetings of the Euro area Heads of State and Government twice a year and when necessary in extraordinary session. The heads of state mandate would be to check the proper implementation of the Stability and Growth Pact by Euro Member States, to discuss the problems facing individual Member States of the Euro area and to take basic decisions on crisis prevention. These summits should also assess the evolution of competitiveness in the Euro area and define the main orientations of the economic policy.

The Heads of State and Government of the Euro area should elect a chairman as a rule for a term of two and half years. Sarkozy and Merkel suggest van Rompuy, who is already president of the Council, to be first to take over this job.

Structural adjustment or the silent coup

Apart from fiscal consolidation Merkel and Sarkozy also want structural reforms, in particular in the areas of labour market, competition in services and pensions policy. In practice this means deregulation of labour markets, wage moderation, further liberalisation and privatisation of the service sector and raising the age of retirement as in Germany.

However, it is unclear at the moment if they can impose their proposal on the other members of the Euro group. In particular in Southern Europe and France the further dismantling of the social welfare state might encounter mass opposition.

Trade unions, many NGOs and other critics are opposing this type of structural adjustment. Resistance have started to organise. Social movements have called for a European day of action against austerity on October 15, 2011. A debate between the EC and civil society – organised by TNI (Transnational Institute) and ATTAC Europe will take place on October. and the entire civil society is preparing actions around the G20 summit in France on November 3-4, 2011.

*Peter Wahl is a researcher at WEED, a German policy institute, where he works on issues of world trade and international finance. This article first appeared in the September issue of ‘EU Financial Reform’ newsletter, which is part of the project ‘Towards a Global Finance System at the Service of Sustainable Development’, implemented by six European NGOs with the aim of ensuring that European economic stimulus packages do not impact negatively on development. [IDN-InDepthNews – September 17, 2011]

2011 IDN-InDepthNews | Analysis That Matters

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