Italy

EVEN in a grouping as fractious as the euro zone, tonight’s falling-out was remarkable. Jean-Claude Juncker, who presides over the zone’s finance ministers, lashed out at the many figures who have more or less openly threatened Greece with expulsion from the euro if it does not abide by its programme of economic reforms and austerity measures.

With Greece in deep political turmoil (some are even talking apocalyptically of civil war) after voters backed an incoherent constellation of anti-austerity parties, European central bankers and finance ministers have been warning it that its departure from the euro is inevitable if it does not abide by the terms of its bail-out.

One of the bluntest warnings came from the president of the European Commission, JosA(c) Manuel Barroso, who told Italy’s SkyTG24: aIf a member of a club does not respect the rules, it’s better that it leaves the clubaand this is true for any organisation or institution or any project.a

Mr Juncker, who is also Luxembourg’s prime minister, was having none of this. Speaking at the official press conference at the end of a five-hour meeting of euro-zone finance ministers (the “euro group”), he let rip:

I made it perfectly clear that nobody was mentioning an exit of Greece from the euro area. I am strongly against. We are 17 member-states being co-owners of our common currency. I don’t envisage, not even for one second, Greece leaving the euro area. This is nonsense, this is propaganda.

We have to respect Greek democracy. I’m against this way of dealing with Greece, [which consists] in provoking the Greek public opinion and giving advice and indications to the Greek sovereign. Greece has voted, we have to take into account the result. We do hope that a government will be formed in the next coming days or weeks and then we have to deal with that government. We don’t have to lecture Greece.

But the Greek public, the Greek citizens, have to know that we agreed on a programme and this programme has to be implemented. But I don’t like the way of dealing with Greece, those that are threatening Greece day after day. This is not the way of dealing with partners, colleagues and friends and citizens in the European Union.

Mr Juncker’s comments are all the more striking given that, just next to him, Olli Rehn, the Finnish commissioner for economic and monetary affairs, delivered the now-standard warning to Greece about the danger of rejecting the bail-out conditions set by the EU and IMF:

The EU-IMF programme is a very substantial expression of solidarity and support for Greece by the other 16 euro-area member-states. It is in fact a solidarity pact between the other 16 euro-area member-states and Greece, between the 16 parliaments and the Greek parliament. This is what Europe is about. But solidarity is a two-way street. It is a fact that calls for respect of commitments both by the 16 euro-area member-states and also by Greece and its government and parliament. Without a Greek commitment this solidarity pact won’t work, and this is the responsibility of Greek politicians in this very critical juncture. Hence the future of Greece and the welfare of its citizens lie more than ever on the shoulders of Greek politicians to keep their part of the solidarity pact.

One might conclude that Mr Juncker and Mr Rehn were playing good-cop, bad-cop with Greece. More likely, their comments reflect two factors. The first is that Mr Juncker feels free to speak out because he will soon step down as the group’s president (he recently criticised the behaviour of France and Germany). The second is that the euro zone is deeply divided over how to deal with the insubordination of Greek votersaand whether it can withstand the shock of a Greek departure from the currency union. Mr Juncker left open the possibility of renegotiating the Greek package ain exceptional circumstancesa, but only once a new Greek government had been formed and had accepted the reform programme.

Officials such as Mr Rehn argue that, two years into the debt crisis, the euro zone is more prepared than ever for what is now known as aGrexita, having raised its firewalls and started recapitalising vulnerable banks. The manifest fear in the markets, though, suggests that investors are far from convinced about the robustness of the system.

The signs are that nobody really wants a bust-up. Greek opinion polls suggest three-quarters of Greeks want to remain in the euro. And the euro zone can hardly relish the prospect of a Greek default and exit so soon after it agreed to a second bail-out for the country in March. Klaus Regling, head of the euro zone’s rescue fund, the European Financial Stability Facility, said the euro zone has lent Greece a!108 billion ($139 billion) in the past two months alone.

At the very least, euro-zone countries will want to avoid a break-up before July 1st, when the more powerful permanent rescue fund, the European Stability Mechanism, comes into force. German sources said this could be used to recapitalise fragile Spanish banks as a means of preventing the spread of contagion. Intriguingly, last night Mr Juncker said that a!1 billion that had been withheld from the latest tranche of bail-out money to Greece in recent days would, after all, be paid out.

Greek politicians seem to have convinced themselves that the euro zone is bluffing about ejecting their country. But Germany and others are determined to disabuse them. The recent menaces seem designed to achieve two goals: to exert pressure on Greeks to support more mainstream parties in a likely second election, and to prepare markets for the likelihood of Greece’s departure if radicals are returned.

For now, attention turns to tonight’s much-awaited meeting in Berlin between the new French president, FranASSois Hollande, and Angela Merkel, the German chancellor. The discussion will focus on Mr Hollande’s call for a greater emphasis on stimulating growth (see my columns, here and here). But against a sharpening tone, his precise demands remain unclear. German ministers are worried he will press for a big stimulus, as well as for the mutualisation of debt through Eurobondsaas endorsed by a committee of the European Parliament.

Despite much talk of growth, on substance Mr Hollande did not seem to get much support from the euro group; if anything, he may have to embark on austerity himself. Though Mr Juncker said Europe needs a thorough debate on growth, he read out a statement from ministers declaring that the current strategy for fiscal consolidation (ie, austerity) aremains appropriatea. Ministers praised two other rescued countries, Ireland and Portugal, for remaining aon tracka with their adjustment programmes. And they were particularly effusive towards the Netherlands, whose parliament adopted a belt-tightening budget even after the government had fallen.

There was no sign of expected proposals from the European Commission to extend deadlines for some countries to reach their deficit targets. Nor did there seem to be much support for an Italian idea of excluding from the calculation of deficit targets some spending on ainvestmenta.

One issue Mr Hollande and Mrs Merkel will have to discuss is who should replace Mr Juncker as head of the euro group. The frontrunner is Wolfgang SchA$?uble, the German finance minister. But Mr Hollande may have misgivings about having a prominent German take over the job. After his performance tonight, Mr Juncker seems to have killed off the idea, favoured by some, that he would be asked to stay on.

(Picture credit: AFP)

TEN YEARS ago Romano Prodi, the-then president of the European Commission, created a stink when he declared that the euro zoneas budget rules were astupida because they were too rigid. But with the onset of the euro zoneas debt crisis in 2010 the response has been to try to make them even stiffer.

At Germany’s insistence, the euro zone first gave the commission more powers to monitor and enforce deficit limits, including the threat of asemi-automatica sanctions for rule-breakers. And second, almost all members of the European Union were dragooned into signing up to the fiscal compact, a new treaty requiring then to adopt binding balanced-budget rules, preferably in their constitutions.

The election of a Socialist, FranASSois Hollande, as Franceas new president, is causing a rethink in Brussels. There is certainly a change of rhetoric about  a “growth compact”. But in substance, the change may be rather modest.

 To begin with, Germany says the text of the fiscal compact is non-negotiable, a position that Mr Hollande’s lieutenants seem to understand. Instead they want some form of programme to promote growth to be created alongside. Whether this takes the form of a formal protocol attached to the treaty (which must also be ratified), or a looser agreement, is yet to be decided. But with parts of Europe back in recession, leaders agree that they have to be seen to do more to promote growth.

In truth, the idea of growth was never absent from the European response to the crisis. Summits have been debating the issue since January. But fundamentally, in the view of Germany (adopted in large measure by the commission) growth would come firstly from restoring market confidence, by getting a grip on public finances. And secondly it would come from supply-side structural reforms to make countries more competitive and labour markets more flexible. With the rise of Mr Hollande, there is now a greater focus on boosting demand as well.

Although he belongs to the European People’s Party, the same centre-right political grouping as Franceas defeated President Nicolas Sarkozy, the current commission president, JosA(c) Manuel Barroso, warmly embraced Mr Hollande and his call for growth. aI am extremely pleased to see the new momentum that is clearly building in our member states to kick-start the stalled engine of growth,a he said at a press conference today.

Far from being stupid, says Mr Barroso, the euro zone’s budget rules are intelligent, because they allow for aadaptabilitya – though precisely how they can to be adapted remains to be seen (more on this below).

Mr Barroso was careful to say there should be no let-up in deficit-cutting, let alone a splurge of public spending. aDebt-fuelled growth is unsustainablea, he insisted, adding that Mr Hollande emphasised his commitment to bringing down Franceas deficit. 

So what to do about growth if there is little or no more money available? One proposal is to recapitalise the European Investment Bank (EIB), which has started to cut back on lending for fear of losing its credit rating.

Another is to leverage uncommitted bits of the EUas budget, in collaboration with the EIB, to raise new joint aproject bondsa to finance new infrastructure projects. A modest sum of a!230m could generate a!4.6 billion worth of projects, says the Commission. It argues that such investments, for things like trans-national electricity grids and pipelines, would not take place if left to member-states.

These ideas are sensible. Channelling the funds through the EIB, provides some assurance that the projects make economic sense and are managed properly. But even if countries agree to provide the EIB with the extra a!10 billion that the commission is calling for, nobody should think that such extra money will lift the most troubled parts of the euro zone out of their recession.

There is a danger, moreover, of assuming that just because some European-level investment can be of benefit, all European spending must by definition be good. Sadly, this is what the commission is doing when seized the moment to urge members to support its demand for an enlarged EU budget, both for next year and for the seven-year period starting in 2014. aIt will be a contradiction to support growth through investment and not be able to commit the funds necessary to work for that at the European level,a declared Mr Barroso.

It is not, surely, a contradiction to point out that an organisation that still spends about four-tenths of its budget on agricultural subsidies is failing to make the best economic investments.

The commission’s proposals are not new, but it is pleased that Mr Hollande has already made them his own and hopes he will champion them. aWe are seizing the moment to advance our previous proposals in the new political climate,a said Olli Rehn, the economic and monetary affairs commissioner.

The novelty may come in the coming days. The European Commission is in the final throes of debating proposals to relax the deficit-cutting targets. The IMF has made clear its view that the adjustment in European countries has often proven to be too harsh. Its latest work on the effect of fiscal consolidation finds that, in a downturn, deficit-cuttting has a strong multiplier effect that pushes countries into unexpectedly deep recession.

Mario Monti, Italyas prime minister, does not seem to have made much headway in his call for spending on ainvestmenta to be excluded, wholly or partly, from the reckoning of a countryas deficit. Instead, the Commission may agree to give some countries more time to get their deficits below 3% of GDP, the threshold set by the euroas original Stability and Growth Pact. This is what Mr Rehn had to say in a speech on April 5^th:

Contrary to the misleading impression promoted by some politicians and pundits that the EU fiscal framework forces all member states into a ‘one-size-fits-all’ consolidation straightjacket, the Stability and Growth Pact is not stupid. Yes, the EU fiscal framework is rules-based, with clear reference values for public deficit and debt for triggering the excessive deficit procedure and, if needed, sanctions. But, at the same time, the Pact entails considerable scope for judgement, based on economic analysis and its legal provisions, when it comes to its application. The Pact underlines the structural sustainability of public finances over the medium term and implies differentiation among the member states according to their fiscal space and macroeconomic conditions.

All this verbiage probably spells aless pain in Spaina. Last year it posted a deficit of 8.5% of GDP, substantially higher than its target of 6%. It has been allowed to overshoot its target this year, on condition that it keeps its promise to get the deficit below 3% of GDP next year. Though it is not officially asking for a reprieve, Spain may be granted an extra year to make the target.

An obvious time to announce the change could be Friday May 11^th, when the commission is due to issue its spring economic forecast (which will then form the basis of detailed acountry-specifica recommendations at the end of the month).

That said, the commission wants to see greater evidence that Spain is making the full effort to control public finances. It wants to see the budget cuts that Spain has promised this year, and evidence that Madrid is getting a grip on spending in the regions. The commission also wants Spain to draw up a convincing plan to stabilise its troubled banks. Moreover, the commission may push Spain to commit to a two-yearly budget cycle to provide greater clarity. aThe road to medium-term economic sustainability goes through immediate decisive action in structural reforms and financial stability,a said Mr Rehn.

Any move to lengthen the process of bringing down the deficit will have to be weighed against two factors. First is the impact on the markets: will investors fear that such a move heralds the breakdown of fiscal discipline, or rejoice that recession might be less deep? And how to explain the favour done to Spain to other countries, such as Belgium, that were told to cut the budget more deeply to meet their target, or face sanctions?

Whatever the aHollande effecta on European policy towards public finances, the new French president is likely to be confronted with an uncomfortable decision. The commissionas economic forecast is likely to find that, on current policies, France is likely to miss its 3% target next year (the IMF reckons the deficit will be 3.9%). So even before he is formally installed as president, Mr Hollande may be asked to spell out how he intends to keep his promises both to control debt and to relieve Europe of the curse of austerity. Unlike Spain, France is unlikely to get a deadline extension.: it cannot claim to have done everything possible to control the deficit, or that it is the victim of an unexpectedly severe recession.

Europe’s budgetary policy may be getting a dollop of Hollandaise sauce, but beneath it all it will still be the same austere dish.

(Photo credit: AFP)

PRAISE heaven for a boring European summit. aThis is my first summit without talk of default, break-up or catastrophe,a said Enda Kenny, Irelandas taoiseach (prime minister). aWe had a normal, constructive discussion.a The French president, Nicolas Sarkozy, went even further: aWe are not out of the economic crisis, but we are turning the page on the financial crisis.a

A new treaty [PDF] to impose greater fiscal discipline on euro-zone members and eight others (but not Britain or the Czech Republic) was signed today after being negotiated in record time. The fall in the spreads on bond yields of France and others showed the situation was stabilising, said Mr Sarkozy: aIt is a great relief.a The European Union is now trying to turn its attention to promoting longer-term growth [PDF].

If Europe can breathe more easily it is thanks in large part to two Italians called Mario. First, Italyas technocratic prime minister, Mario Monti, has started to pull Italy back from the brink through budget cuts and structural reforms.

More importantly, Mario Draghi, the president of the European Central Bank, has administered a double shot of financial morphineacheap three-year loans to any euro-zone bank that asks for the moneyathat has eased the acute pain. But the euro zone is far from cured: there are worrisome symptoms all over.

To begin with, Greece has more obstacles to overcome before securing the vital second rescue package it has been promised. Whether it can implement all the budget cuts and reforms it has promised is the subject of great doubt. But for now the mood is to push the rescue through; talk of forcing Greece into an early default has died away.

So has the invective against Antonis Samaras, the leader of Greeceas New Democracy party, who has often questioned the EU-IMF conditions imposed on his country. At a meeting of leaders of the European Peoples Party (EPP) just before the summit, Mr Samaras had a long private meeting with Angela Merkel, the German chancellor.

Both sides said it had gone well. Germany said it was reassured that Mr Samaras would stick with the programme if elected in Greece’s general election, expected in April. He said he had voted in favour of it and apaid with the blood of my partya after 21 members were expelled for opposing the EU/IMF demands.

The Greek issue neutralised, for a while at least, there is now a looming clash with Spain. As the euro zone enters a double-dip recession, Spain may be coming closer to a deflationary spiral. Its unemployment rate, at 23.3% last month, is the highest in the EU. And its budget deficit last year barely declined from 2010, standing at 8.5% of GDP instead of the planned 6%.

Mariano Rajoy, the new Spanish prime minister, has been lobbying for his countryas deficit target to be softened, but the summit was having none of it. The conclusions declare: aMember States under market pressure should meet agreed budgetary targets and stand ready to pursue further consolidation measures if needed.a

A novice in European summits, Mr Rajoy has been playing a strange game. He was careful not to discuss specific figures with fellow leaders. But as soon as he emerged from the summit he declared that Spainas deficit this year would be 5.8%, rather than the agreed target ratio of 4.4%. He insisted, though, that Spain would still fall below the 3% deficit limit in 2013, as planned.

The question now is how strictly the European Commission will interpret its new powers to monitor national economies and demand reform, backed with the threat of semi-automatic fines. Senior figures in Brussels say they could in theory live with a Spanish slippage this year.

But they are wary of undermining the new governance system, and of giving recently becalmed markets a new reason to panic. After all, Belgium was recently forced to make additional cuts to meet its target, and Italy has also made more cuts to balance the budget by next year.

Germany, moreover, seems to be in an intolerant mood. There is irritation that the Spanish government is delaying its budget pending regional elections in Andalusia that Mr Rajoy’s party hopes to win, and suspicion that it is inflating last year’s deficit figures to blame its Socialist predecessor. The commission says it wants to double-check the numbers. But a senior source in Berlin puts it more bluntly: aEverybody knows the Spanish are lying about the figures.a

The recession has now reached the Netherlands, causing some Schadenfreude in Brussels. The Dutch, after all, have been the most abrasively hawkish of the northern creditor governments. The latest official forecasts show that, on its current course, the Netherlands would post a deficit of 4.5% of GDP this year, falling to 3.3% in 2015. In other words, it would miss its aim to come below the 3% target next year.

Mark Rutte, the Dutch prime minister, says he is determined to bring the deficit into line, not because the EU is telling him to do so but because he believes in budget discipline. But it is unclear how he can do this, and whether the anti-immigrant and anti-EU Freedom Party of Geert Wilders will continue to prop up his minority government.

Political uncertainty comes from other directions, too. Ireland has called a referendum to ratify the fiscal compact. Mr Kenny has expressed confidence that Irish voters, who have twice rejected European treaties, will vote “yes” this time. Moreover, FranASSois Hollande, the French Socialist presidential candidate, has said he would renegotiate the treaty if elected in May.

A final unsettling factor is the unresolved question of whether to enhance the euro zoneas rescue funds. The easiest way of doing this would be to allow the current temporary European Financial Stability Facility to continue using its leftover funds when the permanent European Stability Mechanism comes into force this summer.

Germany has argued that the current firewall is sufficient given the greater calm in the markets, but has agreed to review the matter by the end of the month. It is under pressure from key members of the IMF who insist that the euro zone must strengthen its firewall before they agree to contribute more money.

For now, though, European leaders are glad to talk of promoting growth, though they mean very different things by the term. The most obvious means of achieving this at a time of austerity is to open up the EUas single market, particularly in services.

Mario Monti, the Italian prime minister, says that as well as a afiscal compacta the EU needs an aeconomic compacta. Along with Britain, Sweden and others, he is pushing for the performance of countries in market liberalisation be monitored more closely. The summit communiquA(c) calls for a ascoreboarda to compare the performance of member states, and aregular monitoringa in future summits.

This could set up a potential future clash between northern liberals, now backed by Italy and Spain, against France and Germany, that for the most part prefer to protect the services industry. Mr Sarkozy, for one, says he will not have a repeat of the hated Bolkenstein directive that partly liberalised services and led to controversies about the legendary aPolish plumbera. German officials like to mock Britain for placing too much emphasis on financial services at the expense of industry.

The leaders have many reasons to engage in happy talk about the euro zone turning the corner: Mr Sarkozy is campaigning for re-election, so wants to take the credit for saving the euro; Mrs Merkel wants to get the world to stop asking for more money; Mr Monti wants to break the Franco-German duumvirate by building alliances with northern liberals on the issue of the single market; Ireland and Portugal want to distance themselves from Greece; and many want to avoid structural reforms that may be even harder than cutting budgets.

Above all, they all hope they can change perceptions. aThis is a psychological crisis,a says one senior source, aIt is a matter of confidence. The consumer has abdicated. When you keep hearing talk of Greek default and the end of the euro, you will save your money rather than spend it.a

Some argue that Mr SchA$?ubleas very pro-Europeanism heightens his sense of betrayal by Greece, and the prospect that it could destroy the European Unionas greatest experiment in integration. There may be truth in this. But I cannot help but feel that that also something of the bad-cop routine in Mr SchA$?ubleas actions. He must act as if a Greek default is possible, even desirable, in order to turn the pressure on Greek politicians. If that means being portrayed as a Nazi, so be it; the alternative is to let Greek politicians think they are immune because the euro zone will never let them collapse.

Still, Mr SchA$?uble’s claim that the euro zone is ready for a Greek default sounds implausible. Last year European politicians were bending over backwards to avoid any sort of default, lest it destabilise the whole of the euro zone. Yes, the European Central Bankas massive liquidity programme for banks (not sovereigns) has taken the edge off the panic. The reforms being enacted in Italy and Spain have helped too.

But nobody thinks the euro zone has yet overcome the crisis. If it were otherwise, why insist on the fiction that the restructuring of private debt is avoluntarya simply to avoid triggering credit-default swaps? And surely, if Germany were serious about cutting off the Greeks it would be doing more to strengthen anti-contagion measures. On the contrary: Germany has so far resisted a proposal to strengthen the rescue fund by maintaining the temporary European Financial Stability Facility (EFSF) even after the creation of permanent European Stability Mechanism due later this year.

The conundrum for the fiscal hawks is that issuing a credible threat to Greece requires issuing a credible guarantee that Italy and Spain would be protected from the consequences. But that is something that Germany will not do, for fear of reducing the reformist pressure on Italy and Spain. So through gritted teeth, Greece must be kept afloat in some manneranot at any cost, of course, but for some time yet, as long as the price is not too exorbitant. aWe continue to believe that Greece can be saved. Or at least we continue to say so,a says one Eurocrat.

The difficulty in imposing discipline and reform on Greece will be familiar to any parent of recalcitrant adolescents who do not want to do their homework. Dad may shout, cajole and threat; the kid may come to hate the parent. But if the kid refuses to study, he cannot be starved, beaten or thrown on to the streets. The parent may enjoy the illusion of infinite power, but authority ultimately involves much bluff.

Tough talk. But it is hard to imagine the Dutch wrecking a deal on their own if the Germans have decided to grant the second bail-out. Does the Netherlands really want to provoke another round of the crisis now that its economy is in recession? Indeed, Dutch sources whisper that the minister’s words have been overplayed.  More likely, Mr de Jager is living up to his reputation as the hard man of the Eurogroup, whose job is to stiffen Germanyas resolve.

The real issue for the finance ministers is to try to fit the ever-deteriorating Greek numbers within two self-imposed conditions. One is that the restructuring of Greeceas debt should reduce its burden down to aabout 120% of GDPa by 2020. The other is that that the contribution of governments to the second package should be a!130 billion (including some funds left over from the first a!110 billion bail-out) after the “voluntary” losses being negotiated with Greece’s private creditors*. Both are somewhat artificial figures. The debt ratio of 120% was chosen because it is the level of Italy’s debt; the contribution of a!130 billion was decided in October, so cannot be changed for fear of giving the impression that Greece is a “bottomless pit”.

But as matters stand at the start of the meeting, the package would leave Greece with a debt burden of 129% of GDP a too high for many of the creditors. Tonight’s homework for the ministers will be to fill the remaining fiscal hole: by convincing the ECB to forego profits on the bonds it bought at a discount (it has more or less agreed to do so) and perhaps by reducing the interest rate that Greece is charged by its creditors.

For lovers of numbers, the details of the options are reported in some detail in the FT (here), the Wall Street Journal (here) and Reuters (here).

But even if a deal is agreed tonight, big questions remain. How long will it be before Greece must come back for still more money? And if it must be kept permanently under threat of default, what is the chance of restoring the confidence needed to help Greece recover? For now, the ministers seem ready to play for time, in the hope that Italy and Spain can be stabilised. They will no doubt express confidence that the Greek problem has been settled once and for all. But sooner or later, they will be back for more crisis talks.

* insert

Update 22:00 – The word is that it’s going to be a long night. The finance ministers are busy with another round of negotiations with Greece’s private creditors to squeeze a bigger “voluntary” contribution, beyond the 70% loss negotiated so far.

Update 22:20 – The scale of uncertainty about the prospects for Greece are highlighted in the IMF’s debt sustainability assessment, which concludes that, if Greece does not carry out structural reforms, its debt ratio could reach 160% of GDP in 2020. From Reuters:

… a scenario of particular concern involves internal devaluation through deeper recession (due to continued delays with structural reforms and with fiscal policy and privatisation implementation). This would result in a much higher debt trajectory, leaving debt as high as 160 percent of GDP in 2020. Given the risks, the Greek program may thus remain accident-prone, with questions about sustainability hanging over it

Update 02:30 – A more detailed account of the IMF’s debt sustainability report is here, from the FT’s Peter Spiegel. Diplomats claim the leak is having little impact on the negotiations. But it will have a big impact on the journalists’ interpretation of the deal of the credibility off the deal – if and when it is reached.