Light at the end of the Eurozone tunnel

Participation of Olli Rehn, Vice-President of the European Commission in charge of Economic and Monetary Affairs and the Euro, in the EC/ECB joint conference on Financial Integration and Stability, (EC Audiovisual Services, 25/04/2013).

Participation of Olli Rehn, Vice-President of the European Commission in charge of Economic and Monetary Affairs and the Euro, in the EC/ECB joint conference on Financial Integration and Stability, (EC Audiovisual Services, 25/04/2013).

Dr Wolfgang Schaeuble, the German minister of Finance, drew yesterday his chauvinist rhetoric one step further, by denying the proposal that an increase of consumption demand in his country, could help the exports of the ailing Eurozone countries like Spain, Greece, Portugal, Italy and others. His outright denial was unfair, because he was in the Spanish city of Granada, together with his Spanish counterpart Luis de Guindos. Schaeuble also insisted that even more efforts for growth in Germany proper could not help others.

It seems that lately Schaeuble is losing his temper very easily. Last week he made a grossly impolite comment over a Barroso statement. The President of the Commission had said that the austerity policies in the EU have to be now accompanied by growth measures, not in words but in practice. Seemingly, as the camp of the Europeans who support a change of course from the lopsided austerity policies strengthens, the Germans are becoming more aggressive.

The fact that this country is holding a general election in September and the visible very strong desire of Angela Merkel to win another term in power, is transforming in the short-term the European politico-economic environment into a mine field. The more the Merkel-Schaeuble duo wants another term in government, the more their rhetoric will be ringing the chauvinist chords of the German people, against the ‘lazy’ Southerners. As we will see, however, this conjuncture will be very short-lived. Whatever the outcome of the German election the next day will be very different for Eurozone.

The ‘other side’

Fortunately enough the ‘other side’ is gaining every day more ground not only because the socio-economic situation in the South has become almost completely rigid, but what is even more important, it seems that the political clout of countries like Italy, Spain, Portugal and Greece has strengthened. Despite the Germans refuse to see it, the markets have visibly increased their confidence towards those countries. The Spanish and the Italian interest rates have reached their lowest levels for years.

Cheaper loans for Italy and Spain

Italy’s exchequer offered yesterday 5-year and 10-year bonds of a combined value of €6 billion. The average yield achieved in the auction for the five-year debt-paper was 2.83%, way below 3.65% at the previous auction on March 27. The 10-year bonds were sold at a yield of 3.94%, down from 4.66%. Those interest rates are the lowest for the Italian debt for the last thirty. Demand was also very robust in relation to the last auction.

Unquestionably the markets estimated that the new Prime Minister, Enrico Letta, will manage to actively promote the country’s interests. Letta announced that today Tuesday, right after the approval of his government by the Senate, he will fly to Germany to meet Angela Merkel. Sources in Rome say that in Berlin he will spell out to the Germans his new terms for the entire Eurozone, including the European Central Bank. Italy considers the ECB as the key to unlock Germany’s stubbornness.

This brings us to the role that ECB plays for quite some time now, so taciturnly that its role is barely mentioned. We have to watch carefully the reactions of the Germans in order to understand what Mario Draghi is really doing. The last incident that the Berlin got furious with ECB and not only with Draghi, was in the Cyprus issue. The ECB kept supporting the Cyprus Popular Bank (Laiki Trapeza) until the very last moment of its existence. Over the last twelve months leading to the CPB’s resolution, the ECB kept supplying it with unbelievable amounts of liquidity of the order of €9.5 billion, on non-existent collaterals. The German were outraged with that. Yet the ECB did it.

ECB’s decisive role

But it’s not only that. The very low-interest rates Italy and Spain now pay for their new debts have to be attributed to the unspoken reassurances by the ECB, under the quite successful scheme of the Outright Monetary Transactions (OMTs). As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) decided on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets. According to ECB’s Governing Council the aim was “at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy”. In this framework the ECB announced that it will intervene “with unlimited resources” in the secondary markets of national sovereign debt of all and every Eurozone country. The official target was to safeguard the transmission of the monetary policy to those national markets. In doing so however the ECB was promising at the same time, without saying it, that it will help Italy and Spain to continue borrowing at very low-interest rates.

Indirectly Eurozone’s central bank was almost guaranteeing the entire debt of those two countries. So successful this policy instrument of ECB was, that the central banks hasn’t yet spent not even one euro, to keep the borrowing cost of Italy and Spain at very low levels. By the same token however this tool was pretty much like the issuance of a Eurobond, in the sense that in a way it mutualised for the Entire Eurozone the obligations of its individual member states. Where else could lead the “unlimited intervention”, in the secondary debt market? Germany accepted that in view of the quite difficult conjuncture of summer 2012, with the Eurozone risking unravelling.

Today, however, not only Italy and Spain can borrow at very low-cost, but also all the three Eurozone programme countries Greece, Portugal and Ireland (more so this last one) have almost convinced the international investors, that they can effectively control their deficits. Actually in all those three there is a strong improvement of structural primary fiscal balances since 2009. In Greece, this is estimated to have improved by more than 14 percentage points of GDP between 2009 and 2012. Also in Greece, Portugal and Ireland, the current account balances have improved by more than 7 percentage points of GDP between 2008 and 2012. Only Greece runs today a current account deficit of only 2% of the GDP.

In short, the three programme countries which are officially under the financial management of the troika (European Commission, European Central Bank, International Monetary Fund), plus Italy and Spain have gained a new bargaining advantage vis-a-vis Germany. Actually they can drag Berlin, with some help from Paris, to new policy directions including some debt forgiveness or haircut.

Debt forgiveness?

The new Southern momentum was manifest in Madrid’s last decision announced yesterday to apply two new economic programmes. The first reaction to that by the European Commission was also a real test for Germany. According to the EC announcement, “The Commission welcomes the approval of Spain’s National Reform Programme and Stability Programme…The Commission will now examine the policy plans set out in these two programmes, to assess to which extent they are adequate given Spain’s excessive imbalances…Regarding the fiscal targets, the postponement of the correction of the excessive deficit (to below 3% of GDP) to 2016 is consistent with the current technical analysis by the Commission services of what would be a balanced – but still ambitious – fiscal consolidation path, given the difficult economic environment”.

It’s not clear if the Germans working in the Commission services had seen this announcement, but if they have and let it go, Berlin will reprimand them strongly. In this announcement the Commission says almost openly that the postponement of the correction of the excessive deficit to 2016, may not prove enough “given the difficult economic environment”. In reality the Commission recognised indirectly that Spain may need more time even beyond 2016, to correct its imbalances. Probably that is why Wolfgang Schaeuble was almost rude against the Southerners speaking yesterday in Granada.

All in all, pressures from the South seem to have visibly strengthened making less austerity possible. Of course nothing concrete is expected to this direction, until after the German elections in September. After that however there will be changes, not because Germany will be defeated but because the Southerners have already secured a much better negotiation position. With the political situation in Italy stabilizing, the only black political spot in the south of Europe remain the good performance in public opinion pools, of the Greek major opposition populist political party of SYRIZA. This and the rise of the extreme right-wing fascist and racist party, Golden Dawn (Chrisi Avgi), will continue being the soft spots of Greece’s political scenery. They can also be used though by the government of Antonis Samaras, as an additional argument, against the Teutonic austerity imposed on the country. In either way the first fair winds in the Athens skies will send away the odour of the extremists. Then the entire European South could expect to start emerging, slowly but surely out of this deplorable present.

the sting Milestone

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