The eurozone may not be out of crisis but the European response is working, said Klaus Regling, managing director of the European Stability Mechanism (ESM), the region’s emergency bailout fund.
He said that, in addition to the well-known efforts by the European Central Bank to stabilise financial markets, periphery countries have made meaningful structural changes that are now setting the stage for growth.
Their interest rates have come down and countries such as Spain, Portugal and Ireland can now refinance debt directly from global investors, rather than rely on the ESM. Spain and Ireland have now exited ESM support programmes, and the Europe-wide economy is slowly growing – and by some measures with a better employment outlook than in the US.
Luxembourg-based Regling is a regular visitor to Asia. “I’m a salesman,” he told FinanceAsia. The ESM and its sibling institution, the European Financial Stability Facility, rely on borrowing to finance rescue lending and capital injections. Asia including Japan now accounts for 21% of the two issuers’ global investor base.
That sales effort is not helped by reports in the English-language press attacking EU efforts to deal with the problems of the euro. Those criticisms point out that solutions have not included debt mutualisation, no common taxpayer-supported backstop for banks, no debt forgiveness and nothing to spur inflation. Rather the European policies have focused on adjustment through austerity and deflation in periphery countries. Stress tests on banks, meanwhile, have lacked credibility.
The only European support mechanisms, so the criticism goes, are the European Central Bank’s willingness to intervene by buying bonds via its Outright Monetary Transaction (OMT) programme and via the ESM, which is backed by taxpayers but which only lends according to overly strict covenants and which may be too small anyway if Italy or France ever require a bailout.
The result is high unemployment, particularly among young people, and suffering in the EU periphery as living standards there are slashed and Germany and other relatively rich export-led EU economies avoid direct support for their beleaguered neighbours.
That is the line of criticism routinely aired in English-language media. Regling thinks it is largely wrong, and not just because of the positive developments he cited.
Adjustment in countries such as Greece, Ireland and Spain has brought down their fiscal deficits, while restructuring is making their industries competitive again.
The tragedy of unemployment is real but labour markets are lagging indicators and it may be a few more years before citizens in these countries prosper.
However, these countries will be the outperformers over the medium term – just as Indonesia, under an IMF programme, was forced to restructure in 1998, thus setting the stage for its stellar performance in the 2000s, said Regling, who served as an IMF official in Jakarta in the early 1990s.
He argued against the idea that Germany and other northern countries have not made sacrifices for periphery countries. He said this idea reflects the assumption that Mario Draghi’s OMT is the only factor in stabilising European financial markets. There has been debt forgiveness for Greece, with private creditors accepting substantial haircuts, while ESM has lent to Athens at 1%-2% rates of interest, far below market rates.
Regling is unapologetic about the burden of adjustment falling on troubled countries. However, the five countries that have been recipients of ESM or ESEF money (Spain, Portugal, Ireland, Greece and Cyprus) have been OECD club leaders in restructuring.
Lingering questions
There remain lingering questions about the eurozone that Regling could not address directly. The problems of Greece and other periphery countries may have been comprehensively addressed. Bank reform remains an issue, although a new round of stress tests is expected to be more robust, given that the ECB has now staked its reputation to that process.
There is a new set of European institutions coming online that are meant to recapitalise banks or create backstops if banks fail. The philosophy is that different fiscal and regulatory regimes can coexist within a monetary union if policy coordination is strengthened. These arrangements are a work in progress and have yet to be tested.
The ESM and its predecessor, EFSF (which was replaced because the EFSF was created specifically for just Greece and Portugal, wheras ESM addresses any eurozone member), have been designed along the same lines as the International Monetary Fund. That is, they are funded by capital borrowed from public markets and lent to member states only on the basis of covenants requiring restructuring.
The ESM’s mandate is to lend up to €500 billion ($683 billion) but so far it has only disbursed €49 billion; together with the EFSF that figure is €222 billion out of a €700 billion lending capacity. That leaves the ESM €451 billion of untapped lending strength.
There are nagging questions as to whether that would be enough to handle a failure by, say, Italy or France. However, the ESM would not be on its own if another eurozone crisis broke out. The ESM’s strength is that, like the IMF, it can impose conditions upon borrowing countries. The ECB cannot do that but the central bank has virtually unlimited firepower; together the two institutions can deliver considerable support.
The hope, presumably, is that they won’t need to do so – and the ESM would have to raise money from the markets in order to finance any rescue operation. How easy that would be in the midst of a big-country crisis is another unknown.
Current obligations of €222 billion extend 30 years. The average bond issue by ESM and its sibling (which is being decommissioned) is six years. That adds up to roughly borrowing €30 billion per annum, making ESM one of Europe’s largest borrowers, and currently its biggest agency borrower.
Refinancing that ultimately falls on the shoulders of the recipient governments, so if interest rates rise, the refi cost will go to the likes of Greece and Spain, not to EU taxpayers.
For the moment, the ESM’s borrowing needs are straightforward. It will remain that way if it does not need to initiate another rescue programme. The ESM issues euro-denominated bonds in large tranches (up to €8 billion at a time) and has a credit rating of AA1 (Moody’s) and AAA (Fitch).
In Hong Kong and other sources of capital, the ESM competes for the attention of central banks, commercial banks, insurance companies and other investors – hence Regling’s routine visits to the region, and his desire to get the message out that the recovery of peripheral Europe is intact.
