Tag Archives: European Stability Mechanism

What’s Behind the New Eurozone Fiscal Stability Union?

This European Council meeting was quite tumultuous, it appears. But we do have an outcome – a “fiscal stability union”. Below I present a preliminary critical assessment of the proposal, as well as a comment on the toxic role of the United Kingdom in the negotiations.

The “Fiscal Stability Union” in a Nutshell

The statement of eurozone leaders is scant on details. However, what we know is that:

  • The golden fiscal stability rule that annual structural deficit should not exceed 0.5% of nominal GDP will be enshrined in eurozone Member States constitutions or equivalent acts;
  • There will be an automatic correction mechanism in national legislation that shall be triggered in the event of deviation;
  • There will be common standards for the automatic correction mechanism and compliance with those standards will be monitored by the European Commission; the transposition of those standards will be subjected to the jurisdiction of the European Court of Justice;
  • Eurozone Member states will have to report their national debt issuance plans;
  • When a Member State breaches the 3% budget deficit ceiling there will be automatic consequences unless a qualified majority of Member States decides otherwise;
  • Some of those measures will be pursued by more active use of enhanced cooperation.

Urgent Measures

The eurozone leaders have also agreed on a couple of urgent measures:

  • The European Stability Mechanism (ESM) treaty will enter into force as soon as Member States representing 90 % of the capital commitments have ratified it, preferably by July 2012;
  • Ensuring a combined effective lending capacity of EUR 500 billion by the European Financial Stability Facility (EFSF) and ESM;
  • Provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans;
  • Unanimity for the ESM will be replaced by a qualified majority of 85 % in case the Commission and the ECB conclude that an urgent decision related to financial assistance is needed.

Legal Analysis of Proposals

Given the objection of the United Kingdom, and possibly Hungary, the revision of EU Treaties seems impossible at the moment. That is why the eurozone leaders speak about an “international agreement” that should be signed by March 2012. This agreement will not be part of EU law (at least initially). I fail to see, though, how can the European Commission participate in the monitoring of fiscal stability in this case. Enhanced cooperation (Art. 20 TEU and art. 329 TFEU) seems more appropriate. The problem there is that only the European Commission can propose an enhanced cooperation to the Council, and the European Parliament must also approve it. This can lead to substantial delays of the procedure. That is why a two-track strategy appears more appropriate. Common standards for fiscal stability should be specified in the “international” agreement. Together with it the eurozone member States should initiate an enhanced cooperation authorization procedure. That is important, because any credible fiscal stability regime will need to transfer monitoring powers to the European Commission. This means that the drafting of rules must start now, in close cooperation with the European Commission and the European Parliament.

The Toxic Role of the United Kingdom

For some time I have been quite skeptical of UK’s role in the European integration process. There are deep divisions within the British political establishment on UK’s place in the EU. However, those internal divisions are spilling over to the EU and creating instability. The truth is that there are too many UK politicians that want the UK out of the EU, and in the European Economic Area.

I fully support the right of UK to define its own place in the integration process. With its decision to object to the new eurozone governance rules, the UK is basically signaling its determination to distance itself further from core EU countries. However, I think that the UK must not be allowed to unilaterally obstruct the further building of the European project. That is why a new political dialogue must be started among EU Member States about the possible modifications of UK’s scope of membership and responsibilities in the EU. This process must reflect the UK’s concerns, as well as the strategic objectives of the Union. What is clear is that we cannot continue to pretend that the UK is on board in support of the integration process.

Dissecting the New Franco-German Proposal for the Eurozone

The German chancellor Merkel and the French president Sarkozy met yesterday and produced this document outlining their new proposal for the reform of the eurozone economic governance. The main points are:

  • Regular meetings of the eurozone heads of state and government twice a year;
  • President of the eurozone coinciding with the president of the European Council;
  • Reinforcing the powers of the eurogroup of finance ministers (whatever that means);
  • All Member States of the euro area to incorporate a balanced budget fiscal rule into their national legislation by the summer of 2012;
  • All Member States of the euro area should confirm without delay their resolve to swiftly implement the European recommendations for fiscal consolidation and structural reforms;
  • Finalizing the negotiation on the Commission’s proposal on “a common consolidated corporate tax base” before the end of 2012;
  • Macro-economic conditionality of the Cohesion fund should be extended to the structural funds;
  • Joint Franco-German proposal on a Financial Transaction Tax by the end of September 2011.

So how to interpret this proposal? I will divide my analysis in two parts: 1. Efficiency to solve the urgent problems of the eurozone and 2. Long-term institutional considerations.

1. Efficiency to solve the urgent problems of the eurozone

This proposal will not solve the urgent problems of the eurozone. It is far from what is necessary to calm the markets and will not help neither the ECB, nor Italy and Spain. While Merkel and Sarkozy did touch upon the creation of a eurozone bond as a distant possibility, they did not make a positive step in this direction. This happens while many experts claim that only two options remain open – the creation of a eurozone bond or the breakup of the eurozone. I firmly believe that a eurozone breakup will be a huge blow to the whole world economy, and some research supports this view. That is why any further dodging of this issue will only add to the damage to the eurozone economy.

2. Long-term institutional considerations

Looking carefully at the Franco-German proposal, there is nothing really new that is being added to the Pact for the Euro. The common consolidated corporate tax base and the financial transaction tax (Tobin tax) are old ideas, and they are being drafted by the Commission. The “eurozone economic government” is nothing more than a high-level political meeting with unclear powers, but probably within the framework of the Euro Plus Pact. The “president” of the eurozone probably adds some weight to the position of the president of the European Council, but again his/her powers are not clearly defined and would probably only deal with coordination.

What is more troubling is the intrinsic logic of these proposals. They stay within the logic of intergovernmentalism, leaving all the important decisions to an intergovernmental body. This is a recipe for failure. It’s infuriating that after sixty years of supranational regulation we resort to an inefficient mechanism that remains prone to the joint-decision trap. We are curing the problem with more of the same, and this will lead to deepening of the problems. If we want to keep the eurozone intact we must give an independent body – the European Commission or another entity, the power to sanction Member States for their infringement of the budgetary discipline “golden rule”. Any other solution will not work precisely the way the current mechanism for ensuring budgetary stability in the eurozone does not work.

This intergovernmentalist trend must be stopped. Nobody believes that the Member States are able to control each other. If we want the integration process to continue, we need to take into account its inherent logic. Otherwise we will only breed hybrids that will live shortly and leave a mess behind.

The Second Greek Bailout: the Details

The leaders of the eurozone have approved the second bailout of Greece that is supposed to finally overcome the debt crisis in this country. The total official financing will amount to an estimated 109 billion euro. The European Financial Stability Facility (EFSF) will be used, but the maturity of the loans will be extended from the current 7.5 years to a minimum of 15 years and up to 30 years with a grace period of 10 years. Lending rates will be around 3,5%, close to the costs of borrowing for the EFSF. The maturities of existing loans from the first Greek bailout will be extended. The private sector will contribute with up to 37 billion euro. Financial institutions will be offered a set of optional forms of contribution, including the buy-back of Greek debt, the extension of bond maturities and the rollover of existing debts. Greek banks will be recapitalized “if needed”.

The EFSF and the European Stability Mechanism (ESM) will be allowed to:

  • act on the basis of a precautionary programme;
  • finance recapitalisation of financial institutions through loans to governments including in non programme countries ;
  • intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional financial market circumstances and risks to financial stability.

The EFSF lending rates and maturities for Greece will also be applied for Portugal and Ireland.

So will the new bailout be effective? It’s hard to say. The economic commentators are somewhat sceptical. Felix Salmon notes that this deal is not enough on its own to bring Greece into solvency. He believes that this is not a one-off event and that the same instruments will have to be used for Portugal and/or Ireland.

It’s clear that the deal will alleviate fears for a financial meltdown in the eurozone. However, the deal does not efficiently address the growth problem for Greece (and by extension for Portugal, Ireland, Spain, etc.). The fundamental problem of the eurozone persists. Until we manage macroeconomic imbalances and structural impediments to growth, we will not be able to overcome the reasons for the current debt crisis.

 

 

The Pact for the Euro: a Summary

The heads of state and government of the еurozone Member States have adopted a new competitiveness pact, called “A Pact for the Euro”. The pact comes as a form of guarantee for Germany in order to increase the funds of the European Stability Mechanism (ESM). You can read more about my concerns about the legality of such a pact here. An early assessment of the Pact for the Euro is available here.

The guiding rules of the Pact for the Euro:

  • It will be complementary to the existing instruments of economic governance in the EU;
  • It will concentrate on actions where the competence lies with the Member States. In the chosen policy areas common objectives will be agreed upon at the Heads of State or Government level;
  • Each year, concrete national commitments will be undertaken by each Head of State or Government;
  • The implementation of commitments and progress towards the common policy objectives will be monitored politically by the Heads of State or Government of the Euro area and participating countries on a yearly basis.

The goals of the Pact for the Euro:

  • Fostering competitiveness;
  • Fostering employment;
  • Contributing further to the sustainability of public finances;
  • Reinforcing financial stability.

The main policy instruments:

  • Monitoring and adjusting unit labour costs (ULC);
  • Removing unjustified restrictions on professional services and the retail sector;
  • Improving education systems and promote R&D, innovation and infrastructure;
  • Removing red tape and improving the regulatory framework (e.g. bankruptcy laws, commercial code);
  • Labour market reforms to promote “flexicurity”;
  • Tax reforms, such as lowering taxes on labour;
  • Aligning the pension system to the national demographic situation;
  • Putting in place national legislation for banking resolution;
  • Developing a common corporate tax base.

 

 

The Irish Bailout: the Details and the Bigger Picture

The details of the Irish bailout are now set:

EU countries and the International Monetary Fund will provide up to €85bn in total, which may be drawn down over a period of up to 7½ years. About €50bn is aimed at bolstering Ireland’s public finances while it implements a €15bn austerity package over the next four years. Of the remaining €35bn, €10bn will be used to recapitalise Ireland’s stricken banks, while another €25bn will be a contingency fund to help support the banking system if necessary. The Irish government itself will contribute €17.5bn towards the bank contingency fund, while the IMF will put €22.5bn towards the overall package. This will also include three bilateral loans from the UK, Sweden and Denmark, with the British contribution being around €3.8bn. Ireland will pay average interest of 5.8 percent on the loans.

More importantly, the Council agreed on speedy introduction of a permanent European Stability Mechanism (ESM). An ESM loan will enjoy preferred creditor status, junior only to the IMF loan. The most important feature are the so-called collective action clauses (CACs). These clauses allow a large majority of bondholders to agree a debt restructuring that is legally binding on all bondholders. CACs are meant to ease the process of debt restructuring. The CACS will be introduced in mid-2013.

The proposal for ESM is supported by the president of the ECB, Jean-Claude Trichet. The president of the European Council, Herman van Rompuy, will present proposals for amendment of the Treaties in December.

There is, however, a problem. The financial markets seem unconvinced. As Eurointelligence notes, the problem is that the market demand for peripheral debt is weak, and from 2013 demand for peripheral bonds may dry up completely due to the bail-in rules. And the 6% interest on bailout loans may be too high for Ireland to stay solvent.

There are some ideas how to handle this. Wolfgang Münchau proposes to separate national debt from financial debt and to turn all outstanding sovereign bonds, existing and new, into a common European treasury bond. He does admit that his proposal is not actually feasible, though.

So a more practical approach is to see whether, after all, the EU rescue system can survive the waves of uncertainty. Spiegel International does just that, and notes that of all the possible next bailouts, one is a no-brainer. If Spain falls, so does the euro.