Wednesday, March 13, 2013

EU Summit - Don't miss the after-party

Today's and tomorrow's European Summit should leave financial market participants rather untouched. However, the after-party of Eurozone finance ministers Friday evening should be followed closely.

When European leaders meet in Brussels today and tomorrow, the sense of urgency and emergency has disappeared. It does not look to be another night-braking or even make-it-or-brake-it summit, but more like a conversational group therapy. However, while the summit should probably fall short in producing far-reaching results, it should at least pave the way for the first test case of the new fiscal framework.

In recent weeks, the discussion amongst policymakers and economists about the right policy mix has flared up again. While critics of the Eurozone’s mix of austerity and structural reforms cited cockroaches and hamsters to make their point, the proponents have pointed to reform progress in peripheral countries. This week’s European Summit should emphasise the need for reforms and austerity. However, the Summit could give the official green light for a shift of fiscal surveillance. Instead of focussing on nominal deficit targets, the new fiscal framework is likely to shift towards structural efforts, not to an overburdened, battered economy with additional austerity measures. Beneficiaries of this regime change should be France and the Netherlands. Both countries run the risk of receiving a fine for not bringing their fiscal deficit below 3% of GDP this year but have delivered the required structural efforts. These two countries should soon receive an additional year to achieve the nominal deficit target.

Next to the fiscal regime shift, record-high unemployment in the Eurozone will be on the economic agenda of EU leaders. The social and political impact from high unemployment could be the biggest threat to the survival of the Eurozone. European leaders could pick up earlier ideas for some kind of solidarity fund to tackle at least high youth unemployment.

And there is more. Yesterday, a special meeting of Eurozone finance ministers was announced for Friday evening. Obviously, the meeting will be on Cyprus and the unsolved issue of a possible bail-in. Several core Eurozone countries have been pushing for a bail-in of depositors as part of a bail-out package for Cyprus. A bailout without private sector involvement could have problems passing national parliaments, particularly the German Bundestag. German opposition parties already signaled that – contrary to earlier bail-outs – it would not support the government. For a private sector involvement, several options look possible: privatization of state assets, restructuring of the banking sector, a bail-in of depositors and/or bank bond holders or a sovereign haircut as in Greece. Obviously, any of these forms of private sector involvement (PSI) could have unwanted averse effects either on Cyprus (as a bail-in could lead to a wide-spread withdrawal of funds, eventually undermining the entire business model of the economy) or other Eurozone countries as the uniqueness of PSI in Greece would be more than only second-guessed.

Apparently, a new proposal is currently circulating. Cyprus could levy a tax on deposits or increase other taxes to reduce the size of the required bailout package. While this could help improving Cyprus’ debt sustainability, it is questionable whether it would meet core countries’ political demand of some kind of private sector involvement. The discussions at Friday’s meeting will not be easy.

It is obvious: While the big summit could fall short on tangible decisions, the after-party should not be missed.



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