The EU Summit: Turning Point or Tipping Point?

Wednesday 27 June 2012 14.54

By Tony Connelly, RTÉ Europe Editor, Brussels

Once again an EU summit is pregnant with a sense of impending disaster, with expectations being lowered all week that a breakthrough can be delivered which will reverse, or even just slow down, the escalating debt crisis.

In the immediate term Spain and Italy’s borrowing costs are threatening to tip both countries – Spain followed by Italy – into a wholesale sovereign rescue that the two bailout funds cannot afford.

In the medium to long term 27 EU governments must also grapple with deep and far reaching changes to the architecture of monetary union.

While a new European Monetary Union (EMU) will not be forged overnight, in a benign scenario, a signal at least from the summit that Europe will do what it takes to really stand behind the single currency, and to break the toxic dependency between sovereign governments and their banks, might just ease the immediate pressure on borrowing costs.

If that happened then the more thorny issue of how to deal with Spain’s bank bailout could be dealt with in a calmer context.

But market behaviour to date indicates that this would be highly optimistic indeed.

So what short term solutions can be realistically achieved this week?

The Taoiseach Enda Kenny has made it clear the immediate dangers facing Spain and Italy need to be addressed in a serious manner at the summit.

Spain is the biggest worry. On Wednesday the cost of issuing 10 year bonds was 6.83%. “We can’t keep funding ourselves for a long time at the prices we’re currently funding ourselves,” the Spanish prime minister Mariano Rajoy said.

Spain’s public debt level has been regarded as relatively low, about 80pc of GDP this year. But if the country draws down the €100 billion euro offered by the eurozone for the rescue of its banks, then the debt level could rise to 90pc.

The Spanish dilemma illustrates the mutually corrosive relationship between banks and governments. Spanish banks have been buying up lots of Spanish government bonds, and when those bonds lose value the banks take a hit and they have to recapitalised by the sovereign; but if Spanish banks weren’t in the market buying government debt, then the interest rate Spain would have to offer to attract private investors would rise even higher.

We don’t yet know how much Spain will need out of the €100 billion for its banking sector or which bailout fund – the existing EFSF or the new ESM – will be used.

Spain has lobbied hard for the rescue money to recapitalise the banking sector directly, so the debt doesn’t go on the sovereign. Berlin has so far ruled this out, but there are reports that German MPs from Angela Merkel’s CDU party are relenting and looking at ways to change the rules of the ESM so it can go directly to the banks.

Another option, being pushed by the Italian prime minister Mario Monti, is for the EFSF and ESM to be used to buy bonds in the secondary market, thus lowering borrowing costs.

Both options will probably come up during the eurozone summit which starts immediately after the conclusion of the full 27 summit on Friday lunchtime.

If the rules were changed it would be up to finance ministers meeting on July 9 to effect the changes. The Irish government would warmly welcome a direct, ESM recapitalisation of banks since it could set a precedent for Ireland’s bank debt to be handled in the same way.

Such a torrid climate may force the hand of eurozone leaders, especially Angela Merkel. The problem is that she is due back in the Bundestag at 5pm on Friday for the vote ratifying the ESM treaty and the fiscal compact treaty.

Whatever about what CDU MPs have in mind, she will find it difficult to sign up to any changes to how the ESM works in Brussels, and then fly to Berlin and spring these changes on the Bundestag. She needs a two thirds majority to pass both treaties.

On the wider issue of revamping the architecture of EMU, all 27 heads of government will discuss it on Thursday night.

Whether Europe can and should move to a deeper political, economic and fiscal union is still in the realm of blue skies thinking, but it is fraught with political and legal hurdles.

The report by the four presidents of the eurozone institutions, Herman Van Rompuy (European Council), Mario Draghi (ECB), Jean-Claude Juncker (eurogroup), and Jose Manuel Barroso (European Commission) will provide the basis of the discussion.

EU officials say the document, which sets out four pillars for change – a banking union, closer political union, a fiscal union and closer economic integration – is not for negotiation at the summit. In other words, Van Rompuy is insisting that these are the elements which must form the part of a longer process of negotiation (an interim report in October, and a fuller one in December).

Once that longer process takes place, of course, elements can be accepted or rejected. But the government is taking comfort from the fact that some form of debt mutualisation (either eurobonds or something approaching them) is now firmly on the agenda.

Figuring out what the German chancellor really thinks about eurobonds is a tricky science. On Tuesday June 26 she was quoted as saying it would not happen in her lifetime. But she qualified it by saying “total” debt mutualisation.

The Van Rompuy report acknowledges that fullscale eurobonds are not achievable in the medium term. But it refers to the idea of pooling short-term debt (eurobills) and the idea advanced by the influential German economic council of a debt redemption fund. This would involve any of the debts of eurozone countries above 60pc of GDP being pooled into a single fund which would be paid off over 25 years.

Again on Wednesday such ideas were given short shrift by Chancellor Merkel. Speaking in the Bundestag she said: “Eurobonds, eurobills, debt redemptions funds are not only unconstitutional in Germany, but also economically wrong and counterproductive.”

Nonetheless, there is a hope, if not an expectation, that if other countries are prepared to surrender more sovereignty at a fiscal level, then opposition to debt mutualisation will be lowered at the end of the process.

But the idea that some subtle choreography and carefully calibrated negotiating positions will lead to a harmonious outcome is probably off the mark. The new French President Francois Hollande sees eurobonds in terms of “solidarity” and he wants solidarity to be happening now and not in 10 years time.

Italy too feels that the debate is skewed too far in favour of a fiscal union and not far enough towards eurobonds.

On the other side of the argument the Netherlands and Austria are also opposed to debt mutualisation.

But the reality is that Germany will not sign up to anything close to debt mutualisation until it is convinced that there is commensurate control which prevents spendthrift countries running up huge debts on the back of a German credit card, so to speak.

That’s where the fiscal union comes in. Berlin would be happy to see more powers handed to the European Commission to prevent reckless spending and borrowing, and it could involve giving the Commission, perhaps even a new European finance minister, the power to march into eurozone capitals and rewrite a national budget if need be.

There could also be a limit on how much debt a country can issue before it has to be approved by the eurogroup.

Such a move would almost certainly require a transfer of powers to Brussels, and thus a fresh Irish referendum.

Aside from balancing shared liability (eurobonds) with shared discipline (a fiscal union) there is also the question of a banking union.

The European Commission feels this can be agreed quickly under its own powers to propose legislation, and that it won’t require treaty change. Under consideration is a centralised European banking regulator, a bank deposit insurance scheme protecting deposits across the EU, and a bank resolution agency which could wind up systemically important banks in ways that don’t burden the taxpayer.

The idea behind the banking union is to prevent excessive risk taking by cross border banks, to break the link between banks and sovereigns, and to take banks out of political control by governments or even political parties. But it will be no easy task. The Commission will have to work out which banks are covered in the union, who will be the supervisor and regulator (the ECB as has been mooted, or another independent agency), how will the deposit insurance scheme work, what will provide its financial backstop, and how will such a union command the support of governments and citizens.

On that note the final element of Van Rompuy’s report is a closer political union. Contrary to what many cynical observers believe, the European establishment knows it has to render any big changes politically acceptable if not popular.

Given the increasingly populist and eurosceptic mood which has taken hold in an age of relentless austerity, this will be a very tall order indeed. Some of the ideas include direct elections for the post of President of the European Commission, and a greater role for national parliaments, perhaps even a second chamber to the European Parliament containing national MPs.

Moving forward on all these big issues will take time, and the whole process of “completing” monetary union will take at least 10 years, according to some estimates.

Wolfgang Schauble, the German finance minister, dismisses suggestions that changes should happen quicker. “Europe has always worked on the basis of two principles: What isn’t possible at first will happen over time, and what doesn’t work will be corrected over time,” he said in an interview with Der Spiegel. “That’s why perfect solutions take so long in Europe. And that’s why we are now improving the architecture of monetary union.”

Such thinking triggers dismay in many capitals and also within the European Commission. The euro, some might say, can’t afford the luxury of waiting for the perfect solution, while Spain and Italy can’t afford to wait much more than a few months.

However, if the ECB intervenes more directly in the bond markets to lower borrowing costs for both countries, and if a quick decision can be taken to allow the ESM to directly recapitalise Spanish banks, then the pressure cooker atmosphere might just ease, and the markets might give Europe some breathing space to start the process of restructuring EMU.

But in every summit to deal with the crisis so far – and this will be the 19th – the markets have never been in the mood to give anyone the benefit of the doubt.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>