The European Union leaders met last week at Brussels and agreed to make key amendments to the treaty governing the euro system. These changes are meant to further deepen the economic union through greater policy coordination. This exercise is more political than economic because it involves surrendering more sovereignty of decision making to the euro system as such. Policy coordination, of course, is a veiled term that actually means many weaker EU nations, currently seeking financial bailouts, will have to adhere to the newly accepted ?common principles of competitiveness?, which will drive the EU economy. The common principles of competitiveness could include coordinating taxation policy, national debt, workers? wage indexation, future social security schemes etc. The EU also agreed to conduct fresh stress tests for the banking system, which appears to have got severely buffeted in many countries facing problems arising from excessive national debt or other toxic assets from the real estate sector, as in the case of Spain.
The EU summit at Brussels, last Friday, concluded against the backdrop of countries like Greece, Ireland, Portugal and Spain going through severe banking/national debt crises, forcing stronger nations like Germany to design bailout packages.
Speaking to German Parliament members belonging to the ruling coalition, one clearly got the impression that Germany is very keen on defending and stabilising the euro currency in the medium to long term. In fact, the political class prefers to play down the growing opposition within their polity to weaker European economies being bailed out by the German taxpayer.
?Only some elderly Germans want to go back to the Deutsche mark. There cannot be a backtrack on the euro. It is the job of our policymakers and leaders to explain the true relevance of the euro. We will do everything to defend the euro. We are convinced about its future,? said a senior Parliament member.
This view was echoed by Dr Werner Hoyer, minister of state at the Federal Foreign Office in Berlin, who said the stability and sustainability of the euro is the primary element of EU?s 2020 strategy. Hoyer launched a passionate defence of the euro by arguing that Germany experienced more stable and less volatile inflation under the euro currency system than it did under the Deutsche mark regime.
Finally, Hoyer said he would urge the Germans to think ?in a global dimension, or at least in a European dimension?.
These sentiments clearly bring out the pressures within the EU following the banking/sovereign debt crises in many parts of Europe. Germany is having to do a delicate balancing act in stabilising the European economy without displeasing its own people. Chancellor Angela Merkel has been at pains to suggest that German taxpayers will bail out other EU economies only if those nations accept stringent austerity packages. There are no free lunches anymore.
Despite making such noises, Merkel?s party has not done too well in the local elections in recent times. She suffered a crushing defeat at the hands of the Green party at a provincial election in southern Germany on Monday.
All this will put further doubts in the minds of the German political class as to how far they should go in bailing out crisis-ridden parts of Europe in the future. In some ways, Germany has no option but to play the leadership role, and show magnanimity, even if it riles the local electorate.
Germany has already agreed to a long-term stability package of $700 billion, which will be administered by a body called the European Stability Mechanism (ESM) from 2013 onwards. In the interim, a European Financial Stability Facility (EFSF) will take care of providing bailout funds for financially stressed economies. Of course, the EFSF will merge with the ESM once the latter is formally launched in 2013.
The ESM will be used essentially bring fiscal discipline among European economies facing national debt problems. Strict IMF-type conditions will be imposed by the ESM to bring economies back to fiscal discipline.
As a senior German Parliamentarian explained, ?All these years we collectively failed to adhere to fiscal discipline in spite of caps on budget deficit and national debt set by various treaties governing the euro system. Even Germany and France, which played leadership roles in the EU system, have been guilty of weakening of these fiscal principles that were breached along the way. So we have to put them back together.?
Under the new arrangement, countries coming for bailout funds to the $700 billion ESM will be assessed by the ECB and IMF before making recommendations for structural reforms. It is certain that Portugal will soon come under the recommendations of the EFSF/ESM as the Portuguese government failed to pass the necessary reform measures on its own last week, in Parliament, after which the Prime Minister resigned.
The ESM will also have the mandate to buy the bonds of weaker EU governments like Greece, Portugal, Spain, Ireland etc in the primary market. This is to ensure that their debt issues are subscribed to and the market?s confidence in their debt returns. An economist at Deutsche Bank explained that weak EU nations with excessive national debt need ESM-like bodies that will hold their debt till maturity. ?Currently, the debt of Greece, Ireland etc are in the impatient hands of foreign investors who want to sell. Consequently, the yields on such government debt is touching unprecedented levels of 10%. This is not sustainable,? said the economist.
The other big question that dogs the entire European community, including Germany, is?what is the extent of toxic assets still lying in the banking system of all these countries. According to one estimate, over $300 billion of asset write downs have to still happen in the banks of both weak and strong economies. German banks, themselves, are said to be hiding about $100 billion of toxic assets acquired from Spain and other countries. In some sense the new ESM is meant to deal with such future contingencies as they may arise.
mk.venu@expressindia.com
