It is getting very difficult to determine what is going to happen next in Europe. Over the last couple of days we have seen a renewed and very strong message from Germany and France that a supra-European debt instrument is not going to happen without some significant adjustment in policy governing national fiscal independence.
European leaders continued to spar over proposals to reverse the region’s deepening debt crisis, with a senior European Union official, Herman Van Rompuy, backing German and French opposition to common debt issuance for the 17 countries sharing the euro.
European financial markets have come off a turbulent week, with investors fearing that the government debt crisis could spread to the banking system if Europe’s policy makers fail to quickly implement institutional change and new structural supports for the currency bloc’s financial system.
In a series of interviews and appearances over the weekend, European Union and key national leaders urged against major embellishments beyond what was agreed on at the EU summit last month. That meeting set a new rescue plan for Greece and approved expanding the size and powers of the EU rescue fund, the European Financial Stability Facility, to include purchasing government bonds to support national debt markets.
Parliaments of euro-zone countries by the end of next month need to approve those changes, as well as boosting its effective lending capacity to €440 billion from about €250 billion previously.
In the interim, the European Central Bank has been buying Italian and Spanish government bonds to keep borrowing costs from soaring to unsustainable levels.
The action has worked so far, but many officials in southern Europe worry that the ECB is only buying time and cannot support their markets indefinitely. They see an urgent need for new institutional support systems to reassure investors.
So does the ECB. Ewald Nowotny, the ECB governor from Austria, spoke to Austrian newspaper Oberösterreichische Nachrichten about of a lack of clarity over what future euro-zone economic government would look like. “The priority in my view is to implement quickly and rigorously the EU Council decisions taken at the end of July for better European stability mechanisms,” he said.
What has become clear is that the push by many southern European countries for the creation of so-called euro bonds to replace national debt markets, creating collective liability for all euro-zone government borrowers, is blocked for the time being.
Those statements were backed up by the Germany’s Bundesbank in their recent monthly report:
Unless and until a fundamental change of regime occurs involving an extensive surrender of national fiscal sovereignty, it is imperative that the no bail-out rule that is still enshrined in the treaties and the associated disciplining function of the cap ital markets be strengthened, and not fatally weakened.
So with no Eurobond the only thing left at this stage is the current plan for EFSF expansion, but it is already well understood that the €440 billion is not going to be enough to cover any more than the current basket of 3 nations, and then only if their economies don’t get worse, which they are. There is simply no way the EFSF can carry the larger periphery nations in its current form, but there certainly doesn’t seem to be any impetus to increase the size of the fund either. Squabbling over the current bailout arrangements has already broken out and that continues with the Dutch Labour Party threatening to veto the Greek loan agreement if it contains any type of collateral clause.
Given that national leaders obviously can’t even agree on the details of existing deals I see absolutely no reason to believe that they are able to negotiate the much more political significant topic of fiscal sovereignty. This is looking like a complete stalemate and at this stage the markets will decide what happens next. I note that CDS rates continue to climb in the periphery:
- Portugal – 935 bps (+39 bps)
- Greece – 2000 bps (+71 bps)
- Spain – 373 bps (+9 bps)
- Ireland – 815 bps (+19 bps)
- Italy – 368 bps (+10bps)
As we have seen over the last 12 months the PIIGS have been forced into austerity budgeting that is lowering their economic output. Under these circumstances I have little doubt that these nations will continue to seek additional funding as their industrial output declines:
Italy’s austerity drive, enacted in exchange for European Central Bank bond purchases driving down borrowing costs, may backfire as it chokes the economic growth needed to ease Europe’s second-biggest debt burden.
Prime Minister Silvio Berlusconi’s Cabinet approved 45.5 billion euros ($66 billion) in deficit reductions in Rome on Aug. 12, the nation’s second austerity package in a month, to balance the budget in 2013 and convince investors that Italy can trim debt of about 120 percent of gross domestic product. That’s the biggest ratio in Europe after Greece, whose fiscal woes sparked the sovereign crisis last year.
While the back-to-back packages aim to eliminate Italy’s budget gap, spending cuts and tax increases risk damaging the economy at a time when the global recovery is stumbling. The measures, already in effect, require parliamentary approval that starts today as Senate committees review the law before both houses vote in September.
“There are clear downside risks to growth emanating from such a sharp fiscal tightening profile, which could tip Italy’s fragile economy into a recession,” said Vladimir Pillonca, an economist at Societe Generale SA in London. That could “weaken revenue growth and undermine the ongoing fiscal adjustment” in the face of other challenges, such as “shocks to risk premiums and/or interest rates.”
This is what has happened in Greece and it is exactly what I am expecting from Italy. As expected the Italian government has the same deluded outlook on its own strength that Greece did before embarking on austerity:
Under the [Italian] government’s worst-case scenario, the economy will grow 0.8 percent in 2012 and 1 percent in 2013, with debt staying at around 120 percent of GDP
We now know that Greece is in a far worse situation than it was 12 months ago, and we are starting to see its banking system collapse under the weight of economic retrenchment:
Greece’s top four banks may take part in a share capital increase of Proton Bank SA (PRO.AT), one of Greece’s smallest lenders, the Greek central bank said Friday.
Specifically, the four banks–the National Bank of Greece SA (NBG), EFG Eurobank Ergasias SA (EUROB.AT), Alpha Bank AS (ALPHA.AT) and Piraeus Bank SA (TPEIR.AT)–may subscribe to a convertible bond issue that Proton is planning.
“The four banks are examining in a positive way their participation in an already decided capital increase by Proton Bank through a EUR50 million convertible bond,” the Bank of Greece said in a statement.
The statement also said that a new board of directors had been appointed at Proton, which includes representatives of both the Bank of Greece and the Greek government.
“Proton’s board will examine as soon as possible all alternative possibilities on strategic cooperation,” the central bank added.
The announcement comes just weeks after a Greek public prosecutor charged seven members of Proton’s board with embezzlement, although exact details of the charges remain unclear. Despite that, the Greek government has not withdrawn deposits it holds at the bank, saying that the embezzlement charges have been leveled against individuals and not against the bank itself.
Proton Bank, which has a market capitalization of EUR22.5 million, in May reported a 71% drop in first-quarter group net profit to EUR1.05 million, hurt by a sharp increase in loan-loss provisions.
So once again, nothing is being fixed and the news continues to worsen.