Italy’s dilemma after Merkel-Hollande agreed loose banking union

European Council meeting 22/5/2013: Herman Van Rompuy, President of the European Council, Enrico Letta, Italian Prime Minister From (from left to right). (European Council photographic library).

Last week the President of the European Council Herman Van Ropmuy went to Rome, to meet the Italian Prime Minister Enrico Letta. This was a very significant move by the EU Council President. Italy is the third largest economy of Eurozone with large and more or less competitive private sector productive structures in manufacturing, services and agriculture, which support millions of jobs and constitute its only hope to exit from the present difficult conjuncture.

Yet the country is in a most unfavourable position in respect to banking credits to the business sector. Its SMEs have to pay more than triple interest rate costs for the same business risks as their German or French counterparts, a result of Eurozone’s financial fragmentation and persistent substantial country risks.

Italy’s dilemma

At the same time the new Italian Prime Minister’s political position is very unease. He is supported by a grand coalition of left and right and his manoeuvring space is very limited. In this respect Letta has warned Brussels, Berlin and Paris that Italy will not endanger its productive infrastructure, because Germany and probably France want to use the fragmentation of Eurozone’s financial market to break down his country’s competitiveness, by depriving its private sector from adequate financing.

He said that this will mean “the absolute catastrophe”, meaning obviously that Italy could possibly search refuge outside Eurozone and return to the lira. In this way the country would regain its lost competitiveness by a large devaluation. Not to forget that Italy produces such a large array of products as France and Germany taken together and exports annually a wealth of more than €400 billion of goods and services. It is the only south Eurozone country which can survive outside Eurozone, an impossibility for Spain, Portugal and Greece.

In this context the Italian demand for the creation of a strong and effective banking union, a new institution which could guarantee a seamless financial market, must be taken seriously under consideration by Brussels, Berlin and Paris. This is of particular importance now, after the French President Francois Hollande and the German Chancellor Angela Merkel agreed last week, that the banking union may not be that much effective and strong so as to guarantee the elimination of the country risk as Letta demands. The European Sting writer Elias Lacon produced a relevant analysis on 31 May. If this is true Italy and the Franco-German axis must be now in dense negotiations.

Rompuy’s attempt

Seemingly in order to discuss and ponder the Italian reaction to the Paris-Berlin agreement, Rompuy went to Rome on Friday 31 May. The President of the Council however took a step forward and reassured Letta that Brussels do not agree with a loose banking union, which will not be able to secure that the Italian SMEs would have the same borrowing options, as their German and French competitors for the same business risks. Already the entire Brussels bureaucracy in the Commission and the Council has supported the position of the European Central Bank favouring the creation of a banking union that matters to countries in difficulties, like Italy.

To make this clear Rompuy after meeting with Letta said, “In June we will also discuss (in the EU leaders summit) the issue of credit to the economy, particularly to Small and Medium-sized Enterprises (SME). The current situation is not satisfactory. In several countries, including Italy, access to credit for SMEs is more difficult and more costly than for SMEs with similar characteristics in other Member States. This is probably one of the biggest obstacles to the recovery right now. The European investment Bank (EIB) can help solve this problem. We expect the EIB to significantly expand the volume and the scope of its activities in support of SMEs. The European Central Bank is also looking at options of addressing the current fragmentation in financial markets and there is scope for joint actions between the EIB and the ECB. To succeed at our June European Council we all need to work hard. And I look forward to continue working with the President and the Italian government“.

In this passage Rompuy tries to marry the Paris-Berlin decision for a loose banking union, with the need to cover the financial needs of the SMEs in Italy and elsewhere in the European south. He offers a more strong intervention of the EIB which can offer substantial volumes of cheap loans to the SMEs. By the same token he also reminds everybody that the ECB is in favour of a strong and effective banking union.

The problem is however that on the one side the EIB cannot cover all the financial needs of the Italian and other SMEs in Greece, Spain and Portugal. On the other side the ECB cannot by itself create a banking union, being unable to overcome the Paris-Berlin political prerogative. If things are like that, Eurozone is once more before another dead-end, with the south being faced with the dilemma. Either stay in and confront the difficulties of the productive structures with other means, like labour market liberalisation and administrative burden reductions, or get out and face alone their over-indebtedness problems.