Euro policymakers, markets further apart than ever July 27, 2010Posted by Yilan in EU, European Union.
Tags: European Commission headquarters
Markets abhor a vacuum, and the perception gap between euro zone policymakers and financial professionals is almost certainly at its widest since the single European currency’s launch in 1999.
That is one reason why southern European countries’ bonds remain under almost as much pressure as they faced before the EU agreed on May 2 on a 110 billion euro bailout for Greece and a week later on a giant financial safety net for euro zone countries.
It also helps explain why interbank lending has dried up in some areas of Europe, with Iberian and Greek banks particularly dependent on the European Central Bank for refinancing.
Bankers and investors increasingly believe Greece is likely to default on its debt in the next three to five years, and many want Europe’s authorities to create an orderly restructuring process to share out the losses and avoid market panic.
Policymakers, on the other hand, believe any talk of default or restructuring is dangerous because it amplifies market panic, undermines the credibility of the currency area and may prevent Greece implementing the radical fiscal adjustment it has accepted.
That was a key dividing line between policy officials, academic economists, international financial veterans and market participants at a forum conducted under ground rules that preclude indentifying speakers.
In one forthright exchange, an investment manager said no investor with fiduciary duties would invest in a country like Greece that is forecast to have a debt of 150 percent of gross domestic product in 2012 and will need to convert a budget deficit of 13 percent of GDP last year into a 5 percent primary surplus to put its debt on a downward trajectory.
Markets were pricing in up to a 50 percent “haircut” on Greece’s sovereign debt, implying significant losses for the ECB and euro zone member states that have lent it money.
“We have 18 months to come up with a European debt restructuring mechanism before this problem is going to hit,” the investment manager said, accusing the ECB and the European Commission of ignoring the problem in their proposals.
A euro zone government policymaker responded that EU leaders had been clear that debt restructuring was “not on the table”.
“Maybe we are in denial, but suicide is not a good way to do business either,” he said.
Policymakers from the ECB, the European Commission and euro zone governments see the key to overcoming the euro zone crisis and restoring confidence mostly in strengthening and widening Europe’s fiscal rules and economic surveillance.
The likely outcome, one of them said, was that the euro zone would “muddle through” with adapted rules.
By contrast, market players, academics and international experts said the crisis had exposed fundamental design flaws in European Monetary Union which have to be addressed for the euro to retain credibility as an international reserve currency.
Among the flaws highlighted were the absence of a fiscal or economic union, the way cheap credit was allowed to fuel real estate and consumer booms in countries like Spain, Portugal and Ireland, and the failure of euro zone countries to think or act as a bloc in social, welfare or labour policies.
Speakers noted that Spain and Ireland, two of the countries hardest hit by the crisis, had respected all the EU’s fiscal rules until their real estate and credit bubbles burst in 2007.
Another big difference between market participants and the policymakers concerned the timetable for overcoming the euro zone’s turmoil.
European policymakers argued that turbulence should abate within weeks, once the European Union has begun to implement austerity measures, conducted transparent stress tests on its top 100 banks and shown that the European Financial Stability Facility backstop is up and running.
But several of the bankers and investors warned it would take years for confidence to return, once there was a clear mechanism for resolving the debts of insolvent states, a recapitalisation of banks found to be at risk and a longer-term backstop for euro zone debt.
Veteran former policymakers from the United States, Latin America and Japan were more optimistic about the euro’s survival and growth as a reserve currency than some European investors.
But they also expected the crisis to trigger bolder steps in European economic and fiscal integration than seem politically feasible in today’s Europe.
A Latin American central banking veteran of financial rescues, arguing against any early move to restructure Greece’s debt, likened the euro zone’s challenge to building a hospital.
“If you want patients to have confidence, you don’t start by building and showing off the morgue,” he said.