Will the Eurozone Firewall Withstand?
Ralitsa Kovacheva, April 10, 2012
Is the eurozone firewall sufficient and will it withstand possible new shocks, euinside`s Adelina Marini and economic analyst Dimitar Ashikov commented in our regular feature euOUTside. As you know, at their informal meeting in Copenhagen on 30 March, the eurozone finance ministers decided to combine the lending capacities of both the temporary and the permanent rescue fund to the amount of 700 billion euros. Adding to that sum the money already paid for rescue operations, the firewall amounts to a total of 800 billion euros.
According to Dimitar Ashikov whether it is sufficient depends on several factors. The first is the so called leverage, which is directly dependent on the credit rating of the guarantor countries. As you know, only a small amount of the money in the bailout funds is paid-in capital, the most is in the form of guarantees provided by the countries, based on which securities are issued and offered to the financial markets, which is how the rescue operations are financed. But after France and Austria have lost their excellent AAA credit rating, the rating of the temporary bailout fund was also lowered. Currently only four countries in the euro area have the highest credit rating, given it is required at least 6 countries to have that. A new downgrade will mean the countries to pay more capital into the fund to enable it to keep raising market funding, which would burden their budgets.
Another important factor, according to Dimitar Ashikov, is clear willingness to be shown the bailout funds to be increased if necessary. And what we see now are rather signs that the funds will not be increased or at least the negotiations will be very difficult. There is a clear political resistance in the donor countries against injecting more money into the rescue funds. Whether the current resources will be sufficient depends also on the "monetary crutch" provided by the European Central Bank to relieve the rescue funds. On the one hand, the ECB has already given signals that the cheap loans to banks would not continue indefinitely. On the other hand, these 1 trillion euros, that have already been granted to banks, have not been very efficient, because the banks used a significant portion of these resources to remedy themselves, and a small part to buy bonds of troubled countries.
It is also very important how decisions in the euro area are taken - according to Dimitar Ashikov, if they take so much time as before, market confidence will hardly recover. Recently the markets were disturbed by the news that the Spanish deficit was much larger than expected. At the same time, the end of June is the deadline for the recapitalisation of European banks. It is yet to be seen whether they can raise market funding and get rid of their risky assets, and to what extent they will need state support.
Since the increase in the eurozone firewall was set as a precondition to increase the IMF resources, according to the economist it will not be easy nor will it solve the problem, because the monetary measures proved to be insufficient. Furthermore, the issue is related to the reform of the international financial institutions, as the BRICS countries stated they wanted to be fully represented in the governance of the global economy. BRICS countries can live without the West more than the West can live without them, Dimitar Ashikov says. He explained that the developing economies can shift part of their growth towards domestic demand, thus maintaining a decent growth level for years, while the West, having too big investments in these countries, has more to lose from the decline of economic activity.
euoutside is realised with the support of Domani Coffee Roasting Boutique, Sofia, 4 Dimitar Hadzhikotsev St.
Full transcript of the conversation:
A.Marini: Hello from coffee roasting boutique Domani. We have gathered again to discuss a very important element - the last element from the plans for tackling the eurozone debt crisis. Of course, this element is the financial part - how the eurozone to do so to support all the measures, it has undertaken so far to deal with the crisis, with money. This was the most awaited by all decision, literally all over the world, but the most disappointing one too. You probably remember that in the end of last year the markets showed unequivocally that unless concrete sums were put on the table they would not recognise any measures against the crisis and this was why the EU leaders did various things. They invented various instruments, aimed at supporting the temporary rescue fund. They pulled the permanent fund to start operations earlier - as of July this year. In the end of the day, everyone, especially EU's partners in the Group of 20 most influential countries in the world (G20) said: "Let's see how much money you will bring so that we can get involved too". And in fact, ever since the meeting of the G20 finance ministers in February it became clear that the G20 would do nothing to financially support the eurozone until the EU leaders say what they would do and how much money they would involve. The crucial meeting was on March 30. It was informal, in Copenhagen. But everyone was disappointed by it because the long awaited decision to combine the two rescue funds - the temporary and the permanent - is a fact but the amount of money is relatively modest - 800 billion euros and on top this amount is the result of accounting balancing tricks.Meaning that not all the money is available. This is why we have gathered here with Dimitar Ashikov to discuss, because, you remember, last autumn it was talked about how the eurozone had to come up with a big bazooka but it started building a firewall instead and now the main question is to what extent it is a firewall, to what extent is it big and is it a wall at all?
D.Ashikov: These two rescue funds that were established, like the stabilisation, the permanent fund, they pulled it earlier because it was planned for next year, as we know. And they pulled it earlier but the joint volume of the two funds and the way they are constructed, according to many, is insufficient to deal with the crisis. Here there are several problems. Firstly, whether this fund will be sufficient or insufficient depends on several factors. First is the so called leverage, which the two funds can achieve, because only 20-25% of these billions we are talking about enter the funds and serve as a guarantee for the bonds these funds issue and raise money to implement the remedying programmes. The leverage that these funds can achieve is directly dependent on the credit rating of the main donors, who are guarantors of these bonds. As we see, the credit rating of a number of countries is at risk and at the moment even the Netherlands has troubles with the deficit. This is one of the countries with a triple A rating and if the credit rating problem goes deeper of these major donors with first class rating, the lowest risk, then these rescue funds will become riskier. Their risk will also be reassessed and then not 20-25% will be needed but 30% or more real money in order to continue emitting the same bonds up to 800 billion.
A.Marini: Which means that in fact the budgets will have to pay ...
D.Ashikov: ... this will exert pressure on the budgets of these donor countries. This is the first element. The second is that, when we talk about these funds, they are purely a financial means to deal with this problem. And in order for them to be effective, these funds must be potentially ready to enlarge, depending on the problems that might occur.
A.Marini: You mean, in case of a need a new country to be bailed out or to recapitalise banks?
D.Ashikov: Or to be topped. There must be a clear political position that they can be expanded to 1 trillion, to one trillion and 200, etc. The latest indications that we see, however, show that this will hardly happen. There is quite a determination that the funds will not be increased ...
A.Marini: More than this ...
D.Ashikov: ... more than this. The negotiations will be very tough if these funds are to be expanded, to put it that way. And here we hit purely domestic political problems because in a number of donor countries there is a clearly stated political resistance these funds to be enlarged, both from the opposition, civil movements, etc. against ensuring additional money and therefore increasing the deficit of their countries. I don't know at the moment, but for example in the Netherlands, how can someone come out before the population with a position to increase the money for the fund, given the troubles with the budget deficit.
A.Marini: And now, as part of the election campaign in France, it was discussed that France might have to borrow money if the funds are to be enlarged, which would increase its deficit too.
D.Ashikov: Yes, but like I said this is a function of the credit rating of these countries and these rescue funds - their risk is a combination of the donors' risk, who guarantee the fund. This is clear. The funds themselves, whether they are big or not, depends entirely on the second line of action, which is practised in Europe right now. This is the purely monetary policy of the European Central Bank. As we know, there were two rounds - one in December and another one in the beginning of the year, but such long-term cheap financing, refinancing of the banks and this is the second line for relieving the crisis.
A.Marini: And to avoid a credit crunch in fact.
D.Ashikov: Thus indirectly to relieve these rescue funds, so that not the entire burden is left on their shoulders. But I would call this a monetary crutch, which is provided to assist these processes. But there are several risks, regarding the ECB policy. First, there is no guarantee that the ECB will continue to make these operations regularly and whenever necessary.
A.Marini: Moreover, the signals are that this will not last forever.
D.Ashikov: Yes, the latest position of the bank from a few days ago was that for now there is no further need. Second, this process is with a very low coefficient of useful action because, when 1 trillion euros are given to the banks, they use a significant part of this money, these resources, to remedy themselves and with the remainder they buy bonds of certain countries with troubles. So, when the ECB helps with, say 100, only 30 go to relieve the debt problem.
A.Marini: We discussed many times with you at coffee that in fact the main problem, which still is at hand and this is what Mario Draghi said at the news conference you are referring to, is competitiveness and how the member states, especially in the euro area, can boost their economic growth. But nevertheless, this entire exercise with the combination of the lending capacity of the two funds was done to some extent to enable the G20 countries to take a share and say "OK, we will agree on increasing our resources in the IMF and thus help you but we did not expect only 800 billion". So, did the plan succeed? How does the G20 perceive it? And aren't we going back to a topic we often discuss here with you, that a simple increase of the resources would not be that easy.
D.Ashikov: The very increase of the resources would not solve the problem and we have an analogous problem to this on the other side of the Atlantic. The Federal Reserve System chief has been repeating for two or three years that this crisis cannot be solved with monetary means and that this cannot happen by pouring money. There were various programmes, various ways to inject money to the financial system. But obviously the result is minor and the problems cannot be solved with monetary means. To what extent can the IMF help with additional resources is also a purely financial factor. But the basic problems in Southern Europe and the countries in real trouble are not purely financial in nature. Generally, their problem is competitiveness, but behind this competitiveness various imbalances are hiding. And even the structure of governance of public finances, because, say in Spain, the budget deficit is hard to control because of a peculiarity. We have regional governance there. Spain has provinces that form by themselves certain municipal and regional budgets and the picture there is more complex. It doesn't have a centralised budgetary structure, as in a number of other European countries, like France for instance, and there are various imbalances, which appear on the level of local budgets and the state has to commit to suppress these imbalances ...
A.Marini: They have problems with the banks too, which have to be capitalised.
D.Ashikov: They do, but they also have problems with the structure of unemployment.
A.Marini: Which is huge.
D.Ashikov: Huge indeed because a large pat of the unemployment is due to various factors, including inadequate structure of training.
A.Marini: Again last week Eurostat released the latest data, according to which the unemployment in Spain is 23%. This still is the highest unemployment rate.
D.Ashikov: Look, no matter how much we talk that the labour market is not open in Europe, after all there are people with sufficiently attractive training, to put it that way. They could find jobs in other European countries. They wouldn't ...
A.Marini: So, the problem is with the low skills, is that right?
D.Ashikov: Not only this, because it might just not be adequate to demand.
A.Marini: Yes.
D.Ashikov: For example, let's say there are too many political scientists. This is what comes to my mind. And these people, staying without work for a long time, it is normal for them to try and find a job in other European countries. The fact that unemployment is not dropping means that you have a training structure, that the labour force in Spain, which is too inadequate to the contemporary European economy. And it obviously cannot find its place quickly. Maybe it should be retrained. Various programmes must be endorsed that would allow it to adapt to the new conditions.
A.Marini: But it is obvious that all this, which we talked many times about, will take a lot of time and it is a matter of absolutely national and even regional, in the case of Spain, policies. This is why we are getting back to where we started. It is obvious that this wall solves nothing, and even it is doubtful if it can solve anything in the short run, because you mentioned the US, which also experiences problems, but there are countries that can contribute - those are China, Russia, India, which said at their annual summit: "Well, we would participate in increasing the IMF funds but you will have to give away some more rights".
D.Ashikov: This is an old problem, which we discussed here, so let me put it figuratively: "you cannot be asked to give money through the window and not be allowed in the house". So, the shareholder structure in these international financial institutions from Bretton Woods does not respond to the economic weight of these countries, especially the BRICS. There was a promise, an agreement, I think it was in 2010, the quotas to be reviewed, participation to be reviewed and therefore the weight of some of those countries in the international financial organisations. But this is happening very sluggishly, very slowly and in the same time these countries, which have solid reserves, are required to actively participate in the establishment of these funds with the aim to support some certain countries in hardship. How will this issue be solved is yet to be clarified. This is a purely political issue. At the latest BRICS summit, point 13 of their communique states that they undertake concrete steps for the creation of a Development Bank and tasked their finance ministers to hold the necessary negotiations.
A.Marini: It is important that we say that this bank in fact is for BRICS and for some other developing countries.
D.Ashikov: Yes, it will implement the policies, defined at the BRICS summits.
A.Marini: In other words, can we say that in fact BRICS is saying to the world: "Well, since you do not allow us in the IMF, we will make a bank of our own and will deal on our own"?
D.Ashikov: OK, what will the format of this bank be? What will the structure of the bank be? What will the objectives of the bank be, is yet to be clarified.
A.Marini: Well, they hinted that infrastructure will be at the centre.
D.Ashikov: Yes, but still this made a lot of influential people nervous.
A.Marini: Really?
D.Ashikov: Since the World Bank President Zoellick, who is now leaving, he said: "This is difficult to happen because they are a bit like an eagle, crab and a pike - they have contrary interests and there is no way this to happen". The very fact that we have such a statement means ...
A.Marini: By an outgoing president ...
D.Ashikov: ... by an outgoing president, means that they are taking seriously these intentions of the BRICS countries because such a bank, if an agreement is reached among them, could evolve in a new quality or a second bank to be created.
A.Marini: And it would have huge resources.
D.Ashikov: And a different objective. And here we see not only a circumvention of the traditional international financial institutions ...
A.Marini: Precisely.
D.Ashikov: ... but also using this bank as a trump card, as an instrument for leverage.
A.Marini: May be for now only as an instrument for pressure but unless it is not responded adequately, they could go on to real actions.
D.Ashikov: Maybe, they will start building such a bank. From this perspective, this year certain decisions need to be taken and to be clearer what will be done.
A.Marini: Well, they clearly stated that by the annual meeting of the Bretton Wood institutions the reform must be a fact, which, this meeting of the IMF and the World Bank I think is in September, but I'm not sure if anything is possible to be done by then.
D.Ashikov: These decisions, especially for the IMF and the World Bank - about the IMF there are technical problems too. You have criteria, on the basis of which a currency is endorsed as a basic currency in the fund. But these criteria change. Sporadically, they are agreed at some meetings, changed, new requirements are put forward. And a nation, on this basis, has weight. Generally, this was happening through the years. There were several reviews and these texts change - about the liquidity on the capital markets of the currency in question, about the volume of its inter-banking deposits, etc. And here the BRICS states have to agree technically ...
A.Marini: You mean among them?
D.Ashikov: Yes, among them, with the current influential factors in the IMF to review these technical requirements.
A.Marini: Which is simply impossible to happen by September, only this.
D.Ashikov: This is what I think too, because this is not a simple process to rewrite certain rules for access of a currency as a reserve.
A.Marini: OK, how do you interpret all these things - the BRICS declaration, which is obviously a statement for losing patience by these countries, which represent a significant part of global population. China already is the second largest economy in the world. And in the same time the size of the eurozone firewall, the signals that come from the US. How can we connect all these things?
D.Ashikov: The situation is a bit paradoxical because, if I can put it that way, the BRICS countries can live without the West but the West cannot live without the BRICS.
A.Marini: As we were talking with you earlier this week - the eurozone will start begging ...
D.Ashikov: Yes, but for example, a number of BRICS countries, say China, they can redirect part of their growth inwards, in the direction of domestic consumption. In other words, they have a real opportunity for such manoeuvres. This is valid for other BRICS countries as well. So they can sustain their growth at a decent level for years. They also have the resources to do that. They have the financial buffers to do it. From the West's perspective, the West has too many investments in these countries ...
A.Marini: And a lot to lose.
D.Ashikov: ... and when growth is declining it is balanced at a lower level, but then the economic activity is declining of these companies. Western companies in BRICS countries have much more to lose than the BRICS themselves. BRICS can lose some exports, which have already declined sufficiently during the recession as of 2008. And they are aware that these exports will not recover in the foreseeable future or in the next 2-3 years. The West's bigger problem and its investments in the BRICS countries is that the volumes will drop, the dividend and profit will drop and this will lead to a decline of economic results.
A.Marini: In other words, to conclude this way, could we say that this firewall, which we waited for for so many months, in fact is the real price of the eurozone - 800 billion? Whatever happens, it will have to be withstood?
D.Ashikov: Look, whether it is a lot or not depends on many things which we started the conversation with. It also depends on the confidence the eurozone is radiating in terms of decision making. And if the decisions are being taken so sluggishly as last year, then maybe even if we double this amount it won't do.
A.Marini: And there is already some kind of losing patience. The yields on the 10-years Spanish bonds soared.
D.Ashikov: Of course they will soar after they surprisingly announced that they will not meet the deficit target.
A.Marini: This is another step in the direction of losing confidence.
D.Ashikov: Yes. You have a fixed threshold of 3% and you say - it won't be 5% and something, it will be 8%. I mean, this is hardly something normal. On the other hand, there is another thing that made the markets very nervous, which is why the bonds are soaring. And this is that the remedying of the European banks is yet to come. As we know, by mid-year they have to achieve the needed capital adequacy, which means that we are yet to understand whether they would need additional assistance from their countries. And to what extent can they raise funds on the market? To what extent can they get rid of risky and toxic assets? To what extent can they painlessly transform and respond to these new requirements? This is what we are yet to witness and I guess this is very irritating because the deadline is approaching. It is June 30th or July 1st, and we have less than 3 months. Generally speaking, there are indications here and there that there are banks that have achieved this adequacy, others have already restructured their assets but in general, the whole picture is not clear.
A.Marini: I would suggest that we end there, dear viewers and readers of euinside, nothing is over yet. On the contrary, the eurozone crisis promises, as it seems, a hot summer, no matter the signals for remedying all of us wanted. So, again, it seems, as Dimitar also said, we are yet to witness whether what has been done so far will work, how will it work and whom will it work for.
D.Ashikov: There is one more thing and this is the so called pace and rhythm - the timing of the eurozone. As we spoke in the end of last year, the moment a decision on Greece is taken. In December it was clear what the deal will be, the technical details are a percentage and some proportions. It was clear that the details will be worked out. And the eurozone had to start January with the issue of banks. As we see, the ECB ensured long-term financing. Everything calmed down ...
A.Marini: Until the Spring European Council.
D.Ashikov: ... but three months have passed.
A.Marini: How did the European Council pass? Everything is normal, we can from now on talk about growth, etc., and all of a sudden ...
D.Ashikov: Of course, after Greece, the next month, they had to discuss the banks. And we have 3-4 months of absolute inaction on the matter. Greece is no longer a pressing issue. Which is the next priority of the eurozone? This is Europe's banking system.
A.Marini: But it seems that no one wants to open this topic.
D.Ashikov: Sooner or later they have to and the sooner the better.
A.Marini: OK, this means that we will be seeing each other more often in order to discuss what is going on, why is it happening, so stay with us.