Why Eurozone’s problems may end in a few months

Exchange of views with Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the right), in the Committee on Economic and Monetary Affairs of the European Parliament, photographed here with Sharon Bowles (ALDE, UK), chair of the Committee. (European Parliament photographic library).

Exchange of views with Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the right), in the Committee on Economic and Monetary Affairs of the European Parliament, photographed here with Sharon Bowles (ALDE, UK), chair of the Committee. (European Parliament photographic library).

After Manuel Barroso, President of the European Commission, questioned loudly last Monday the one-sided character of the severe austerity policies currently applied in a number of Eurozone countries, yesterday it was the turn of Commission’s vice President Ollie Rehn, directly responsible for this tough strategy, to argue openly and clearly in favour of a relaxation. It must be noted at this point that, after Barosso commented as he did on Monday 22 April for the austerity programmes applied in a few Eurozone countries, the German Federal Ministry of Finance issued a statement repelling any thought of relaxation. The press release concluded that it is wrong to change a policy in the middle of its application period. Let’s see the time sequence of those facts.

President Barroso, on Monday 22 April participated in a Brussels Think Tank debate under the title of “Austerity and Growth”. After some strong verbal exchanges with the moderating the discussion journalist, Matina Stevis, about the role of the European Commission during the economic crisis years, Barroso felt obliged to focus on the real political dangers threatening the European Union. “The real risk today comes from elsewhere,” the President said: “I am deeply concerned about the divisions that we see emerging: political extremes and populism tearing apart the political support and the social fabric that we need to deal with the crisis; disunion emerging between the centre and the periphery of Europe; a renewed demarcation line being drawn between the North and the South of Europe; prejudices re-emerging and again dividing our citizens, sometimes national prejudices that are simply unacceptable also from an ethical point of view.”

It was a real outburst. He had however to offer a way out from the dead-end he had just described. So he continued like that: “Politically and socially, one policy that is only seen as austerity, is of course not sustainable. That is why we need to combine the indispensable, I underline indispensable, correction of the disequilibria in public finances, namely huge deficits, huge public debt, fiscal rigour, this is indispensable, we need to complement this with proper measures for growth, including short-term measures for growth, because we know that some of those reforms take time to produce effect ….Now, this is indispensable, but it has to be complemented by a stronger emphasis on growth and growth measures in the shorter term. We have been saying this, but we should say it louder and clearer. If not, even if the policy of correction of the deficit is basically correct, we can always discuss the fine-tuning, the rhythm or the pace, but that will not be sustainable politically and socially”.

Seemingly Berlin was annoyed by this remark about “We have been saying this, but we should say it louder and clearer”. It is obvious that Berlin will resist any relaxation of the austerity policies for as long as it will be possible and in any case until the September elections in Germany. The vast majority of voters in this country want Angela Merkel to continue appearing as a guardian angel of their taxes.

Germany to pay for the first time

For this reason the new haircut on the Greek debt that the Eurozone countries have agreed to, as demanded by the IMF, will be realised, after September. The IMF insisted that a country’s debt has to be sustainable, if the Fund’s support is to continue. The Greek debt in order to be viable needs soon a new haircut. Actually this will be the first time that the German taxpayers will be on the losing side in a bailout transaction. Until today Germany had been gaining something out of all Eurozone countries’ bailouts.

Today however, after three Greek programmes, the German exchequer holds one of the largest portfolios of Greek bonds. It will be exactly those bonds to receive a good haircut as the IMF demanded and the German taxpayer will pay for it. Of course Greece has first to produce primary fiscal surpluses (without counting payments of interest on debt) in order to enjoy this definitive and important reduction of its sovereign debts. Until today all revisions of the Greek debt had led to increases of its absolute amount. Now it will be the first time that there will be real decrease and Germany will pay a price for the first time. This is what Merkel wants to avoid happening before September.

It’s not only that however. The discussion that opens nowadays in Brussels about relaxing the austerity policies in the programme countries, namely Greece, Ireland and Portugal will mean that whatever positive measures are decided for the Greek debt they will be also applied in the case of Portugal and Ireland. This last country has already secured a generous reduction of its obligations vis-à-vis the European Central Bank, another large “investor” on Greek, Portuguese, Spanish, Irish and Italian debt. The ECB is bound also to lose money in the forthcoming haircut of the Greek debt. Again up to now ECB is making huge capital gains from its holdings on those countries’ bonds, having bought them at discount in the secondary market and being paid in full on maturity.

In any case if Greece manages to produce a primary surplus in its government budget this year, the whole scenery around the austerity policies will change drastically. This prospect will act as a catalyst for more measures in favour also for Spain and Italy, and of course for Ireland and Portugal. Spain expects a direct refinancing of its ailing banks from the EFSF/ESM, thus relieving Madrid’s exchequer from this burden. In reality it will be a chain reaction after Greece attains primary surplus spreading positive contagion, a prospect that will change the entire economic scenery in Eurozone.

Rehn wants less austerity

Obviously the Brussels Commission is well implied in all that. It seems then that the discussion for growth and relaxation of austerity is not only a personal bet of Barroso and Rehn. This last dignitary speaking yesterday at an Economic and Monetary Affairs Committee meeting at the European Parliament, said openly and clearly that “more relief would be good for Eurocrisis countries” he also hinted “that softening austerity would be justified by rational economic theory but that political constraints imposed by the wealthier countries made it hard to do”.

Actually Rehn went a few steps ahead from Barroso, admitting clearly that Germany is the only impediment towards softening austerity, a proposal which is also justified by ‘rational economic theory’. Given the gravity of Rehn’s the statement, the Parliamentary Committee decided that, “This issue will be debated at the 7 and 8 May hearings with the ECB’s Jorg Asmussen, Eurogroup President Jeroen Dijsselbloem, and Commissioner Rehn on the Troika’s handling of the Cyprus bailout. The IMF will also be heard on the same matter towards the end of May”.

A new environment

Unquestionably the discussion for a new economic environment in the Eurozone has opened. The crucial points in the new path will be the attainment of fiscal consolidation in the programme countries, mainly Greece and Portugal. Ireland has already convinced everybody that it can deliver that. If Athens and Lisbon manage to follow on Dublin’s footsteps during the few coming months, then the austerity and economic downturn period for Eurozone will end, possibly before the end of the year or early in 2014. The success of the new Italian Prime Minister designate Enrico Letta to form a viable government will seal the whole affair. Markets have already understood that and many analysts are wondering why the CDSs and the spreads on the Italian and the Spanish debt are falling fast during the last few days. Some days ago the Wall Street Journal writer, Charles Forelle, wondered why “European Bonds Are Defying Gravity”? Probably the answer lies here above.

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