When Eurozone leaders meet on Sunday to (once again) solve the Eurozone crisis, expectations are high. Can Eurozone leaders deliver?
It is again the week of all weeks, the summit of all summits. It is again crunch time in Brussels on Sunday. Eurozone leaders will meet to present a new crisis resolution package. The framework of the anti-crisis package has become clearer in recent weeks. It is likely to consist of the following elements: bank recapitalisation, further Greek debt restructuring, leverage for the EFSF and new economic governance. However, as so often is the case, the devil is in the details – and it will be in each of these four elements.
The issue of bank recapitalisation has become the new buzz word of the euro rescuers. Bank recapitalisation should help to cushion the negative impact from a possible Greek debt restructuring and possible contagion. However, it is doubtful whether Eurozone leaders can come up with a detailed plan on Sunday, presenting single banks and required capital needs. The most likely outcome, in our view, is a rather general agreement on higher Tier 1 capital ratios (around 8% or 9%) with a timetable on how and when to increase capital.
A further Greek debt restructuring looks like the most tangible result from Sunday’s summit. A renegotiation of the July agreement could see an increase of the so-called voluntary private sector involvement from 21% to around 40%. Higher numbers were circulating initially but have become less likely. Nevertheless, even with a higher private sector involvement, Greece debt would not, yet, return to a sustainable path and Greece would still have a high fiscal deficit. Consequently, more debt restructuring or debt forgiveness is likely further down the road.
Leverage for the EFSF should have the biggest impact on financial market reactions to the Sunday package. The lack of an unconditional lender of last resort in the Eurozone is the biggest shortcoming of the current set-up of the monetary union. There is a growing awareness amongst Eurozone policymakers that even the just recently beefed-up EFSF is too small to fulfill such a role. The EFSF is still only a manual spray gun and not a big bazooka. Simply increasing the size of the EFSF by more state guarantees, however, is hardly possible in the current situation. More Eurozone countries could lose their AAA-ratings upon higher guarantees, thereby toppling the entire EFSF construction. Leveraging the EFSF could be an alternative but this is easier said than done. The currently favoured option by at least the German government is a so-called sovereign insurance mechanism. Eurozone countries could insure newly issued bonds at the EFSF against a loss of x-percent (probably 20%). This could make peripheral bonds more attractive but it still does not address the problem that there is not enough money to eventually bail-out Spain and Italy. Only if the bond insurance could bring peripheral yields down to the same level as EFSF loans and this is unlikely.
The final element of Sunday’s master plan should be a commitment to more political integration and stricter and more centralized economic governance. However, this takes time and requires Treaty changes – something the Sunday summit cannot deliver.
French president Sarkozy raised the bar for Sunday’s Eurozone summit to an impossible height. The current crisis is simply too complex and there are too many devils in the details to come up with a final, all-encompassing package with not a single question left unchanged on Sunday. However, even without the super-duper master plan, Sunday’s summit could bring new steps in the right direction.