Risk aversion is no longer declining and markets are on hold waiting for the conclusions from discussions to shore up the Eurozone. In any case, they will have to be patient a little longer than first expected. Indeed, not one but two meetings of the heads of state and governments of the Eurozone have been convened (on Sunday 23 and likely Wednesday 26 October) to resolve the issues still pending.
Is this extra time required sending a wrong signal to markets? Not necessarily. First the German political set-up is imposing its constraints: the Bundestag is requesting to give a mandate to the chancellor, which means forging a consensus with France and having a debate in Berlin among the executive and legislative powers. Then, at least until recently, the right balance between the different elements under discussion had not been found. Regarding the financial issues, there was still some inconsistency between the different German proposals: a broader PSI for Greece, an ambitious recapitalisation of the banking industry and a limitation of the EFSF. Market participants did not pay enough attention to the link between these financing questions and the strong German request for revising the economic and fiscal governance of the Eurozone.
Everyone must understand that, for Germany, fiscal self-restraint and respect of the common rules are a prerequisite of any new joint action. Germany does not want any effort to end the current financial crisis (sovereign crisis with ramifications for the banking industry) to lead to complacency among the countries ‘under programme’ about the need to carry out more structural and fiscal reforms. Whatever the reforms already launched in order to prevent a repetition of the current crisis (the list is quite long even if there are overlaps between the different subjects, from the European semester to the ‘six pack’ rules and from semi-automatic sanctions to the Euro-Plus pact), more will come.
In terms of co-ordination and surveillance, the focus is on a balanced budget adopted by each member country before the end of 2012, national budgets based on independently produced growth forecasts, a commitment from national parliaments to ‘take into account’ recommendations adopted at the EU level and more generally a closer monitoring by EU institutions of the national fiscal policies. Concerning the governance structures of the Eurozone, the target is to go for further fiscal integration and further economic convergence and thus have the enforcement mechanisms needed. A first set of proposals should be presented in December and a roadmap on how to implement these measures should be finalised in Q212.
There is no doubt that Germany is looking for a strong commitment from its partners on these different points before it shows more flexibility on the more immediate financing questions. In that sense, Germany is right, insisting on the point that finding a solution will take time. The tricky issue is finding a way to increase significantly the means of the European facility. Currently, both Germany and the ECB are refusing to grant a banking licence to the EFSF and so provide access to the central bank’s refinancing operations. The alternative under discussion is turning the EFSF into a bond insurance fund. Concerning the other two points, firstly it seems that the commercial bank-capital shortfall will be lower than previously expected: according to the European Banking Authority about EUR80bn, mostly because the losses on the peripheral sovereign bond portfolio are being mitigated by profits on core countries. Then, the debate on the need to increase the participation of banks in the bailout of Greece remains quite confused. What is certain is that someone (Greek taxpayers, the EU or private investors?) will have to pay in the (very likely) event of Greece missing its deficit reduction target.
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