European Court backs ECB

The ECB’s Outright Monetary Transactions (OMT) programme was legal. The European Court of Justice (ECJ) just released its ruling on the OMT, calling it compatible with EU law. Even if widely expected, this ruling still brings a relief at the ECB and in financial markets. However, at least the press release still leaves the door open for new lawsuits against QE. Remember that OMT was the programme the ECB announced back in 2012 when the risk of a Eurozone break-up had increased significantly. It was the incarnation of Mario Draghi’s famous ”whatever-it-takes” speech in July 2012. Back then, the speech and the subsequent announcement of OMT calmed financial markets and spreads on government bond yields narrowed again, assuming that the ECB had finally accepted a role as the lender of last resort. The ECB, however, has never referred to the role of lender of last resort but has always argued that OMT was a sheer monetary policy instrument, targeted at a proper functioning of the monetary transmission mechanism. While markets were cheerful, some Germans were not and started a law suit against the ECB, putting the OMT’s legality into question. With OMT, this was the argumentation, the ECB had crossed the Rubicon, entered the arena of monetary financing and had put German taxpayers (without any accountability) at risk. The lawsuit was filed at the German Constitutional Court. Then, in early 2014, the German Constitutional Court has basically said that it was unable to assess the legality of the ECB’s OMT but if it could, it would deem it illegal. This is why the German judges had referred the case to the ECJ. The ruling The ECJ just released a first four-pager press release with the main argumentation of the ruling. The entire verdict will be released later today. Judging from the press release, the ECJ gives the clear backing to the ECB. According to the ruling, the OMT programme “falls within monetary policy and therefore within the powers of the ESCB”. OMT contributes to the singleness of monetary policy. The ECB’s role in the Troika Today’s positive ruling does not come as a surprise. In fact, the ECJ broadly followed the advice of its Advocate-General Cruz Villalon. This advice was given back in January this year. However, the Advocate-General had pointed out another issue, which is of great interest. In the event of the OMT programme being implemented, the “ECB must refrain from any direct involvement in the financial assistance programme that applies to the State concerned”. Back then a clear sign that the ECB’s role in the Troika should be revisited. Today’s official ECJ ruling – at least in the press release – does not comment on this aspect anymore. Impact on QE There is no doubt that OMT paved the way for QE, even if there are some substantial differences between the two. While OMT has a built-in conditionality and only focusses on the countries applying for OMT, QE is unconditional and purchases are spread across Eurozone countries. Today’s ruling should clearly discourage new lawsuits against QE, though not entirely. The ECJ states that ECB bond purchases could in practice have an effect “equivalent to that of a direct purchase”, particularly when potential purchasers of government bonds in the primary market new for sure that the ECB was buying in the secondary market. In our view, the ECJ kept the door to new QE lawsuits slightly open. Who has the last word? Anyone familiar with lawsuits knows that there is almost always the possibility to continue. This is why even the discussion on OMT might now be entirely over and solved. After today’s ruling, the crucial question is whether the German Constitutional Court will simply embrace the ECJ’s ruling or not. In 2014, the German Constitutional Court clearly signaled its own judgement, namely that the OMT may well exceed the mandate given to the ECB and would be inconsistent with the prohibition of monetary financing of member states. Even if the European Court would rule favorably towards the ECB, the German Constitutional Court made it clear that it reserves its own judgement and that it would not automatically follow the ECJ’s opinion. In its own view, the German Constitutional Court claims to have the last word in extreme cases. However, even if in theory the German Court could still come with a different ruling, it is hard to see that this would really happen in reality. It would lead to a legal conflict between two strong Courts with reputational damage for all. In sum All in all, today’s ECJ ruling should bring some relief to markets. In these times, when Eurozone policymakers are realizing that a Grexit would lead to contagion on financial markets, at least in the short run, confirming and strengthening the ECB’s OMT is almost existential. Up to now, OMT has been the ECB’s most powerful tool, and actually the most powerful tool which did not cost a single euro. The ECJ gave a strong backing to the ECB’s independence and sent a sad message to some Germans: there is European life outside the German borders.

Fiscal storm ahead?

The European Commission’s latest economic forecasts will be presented on Friday. They should be the prelude to the first test case of the Eurozone’s ever-stricter fiscal rules.

Normally, releases of the European Commission’s economic forecasts pass by almost unnoticed and often lack financial markets’ interest. This time around, it should be different. When the European Commission presents its economic forecasts on Friday, market participants are well advised to have a closer look and pay particular attention to the fiscal forecasts. For the first time, the Commission will present a fully-fledged forecast in February. The forecasts for government budgets will form the basis for the next steps in the Eurozone’s fiscal surveillance.

Of course, fiscal surveillance in the Eurozone has become a rather complex mixture of prevention, correction, early warnings and ultimately even financial sanctions. The most straightforward surveillance is still the so-called Excessive Deficit Procedure (EDP). Enshrined in the Treaty, the EDP is the sanctionary or dissuasive arm of the Eurozone’s fiscal surveillance framework, stipulating a trajectory to correct excessive fiscal deficits and bring fiscal balances back in line with the threshold of 3% of GDP.

Currently, 12 out of 17 Eurozone countries are in an EDP. While the four bailed out countries (GR, SP, IR and PT) still have some time to bring their fiscal deficits back to 3% of GDP, the other eight countries had received 2012 or 2013 as a deadline to, as it is called, “correct the excessive deficit” (see Figure 1). For the countries with the 2012 deadline (IT, CY and BE), it will be thumbs up or thumbs down already before the summer. Normally, the Ecofin should decide on next steps in May. The European Council in June could take final decisions. For the countries with the 2013 deadline (FR, NL, AT, SL and SK), the Commission forecasts should send a clear signal of whether the countries are on the right track for fiscal consolidation or whether more austerity measures have to be taken.

The European Commission’s forecasts of last November suggest that the coming months could be the first big test case for the (once again) overhauled fiscal rules of the Eurozone. Back in November, only Belgium, Italy, Austria and the Netherlands were on track to meet their respective deadlines. Given the worse-than-expected growth environment in 2012 but also prospects for 2013, new fiscal slippages could be expected.

So what if a country fails or looks set to meet the required deadline? Eventually, not sticking to the official deadline could lead to a financial fine. Before this happens, however, the country in question will be given a last chance to take additional austerity measures. Or, following good European traditions, the deadline could be extended.

The option of an extended deadline is seen in the official fiscal rules. To qualify for an extended deadline, two criteria have to be fulfilled: 1) the country has to have implemented the required structural adjustment; and 2) fiscal slippages must have been caused by “unexpected adverse economic events”. An exact definition of these “unexpected adverse economic events” does not exist. In recent years, the severe 2009 recession led to an extension of EDP deadlines.

Given the above, at least three Eurozone countries will anxiously study the new European Commission forecasts on Friday. Cyprus and Slovenia seem to be off track in terms of both meeting the required deadline and fulfilling the structural adjustment. Clear evidence that Cyprus probably needs a fully-fledged bailout, rather than a bailout light only for its financial sector. France is a borderline case and could become the big challenge for the Eurozone’s fiscal framework. Last week, a French government official announced that the deficit target for this year will not be reached. This means that the deadline to bring the deficit back to 3% will be missed and, at the same time, the structural fiscal adjustment so far has anything but outperformed the requirements. Here, the deadline could be extended although sluggish growth, mainly due to home-made structural weaknesses, would obviously not be the most elegant way to define “unexpected adverse economic events”. The same holds for the fact that the economy falls clearly short of returning to the government’s assumed trend growth of 2.5% from 2011 onwards.

For the European Commission and eventually all Eurozone governments the question will be “sink or swim”. Strict application of the rules to regain credibility or softer (and for some smarter) application not to overburden the battered economies with additional austerity? Obviously, there are pros and cons for both options. An interesting side track will be the discussion on the methodology of structural adjustment. The structural adjustment is measured as the change of the cyclically-adjusted fiscal balance; a methodology that recently received some criticism in the context of the fiscal multiplier discussion.

The way forward will be a walk on a tightrope. The decisions of the coming months will not only have an impact on near-term economic prospects but will also more fundamentally pave the way for fiscal surveillance in the Eurozone.

Liegen loont niet

Het kerstmaal komt vroeg dit jaar. Voor financiële markten en vooral Angelsaksische analisten is het smullen: het einde van de euro nadert. De reden is dat de drie modelleerlingen van twee jaar geleden - Ierland, Spanje en Griekenland - nu de grootste zorgenkindjes van de eurozone zijn. De ineengezakte huizenmarkt, de door veel te hoge loon- en prijsstijgingen catastrofale internationale concurrentiepositie en de excessieve overheidsfinanciën zijn meer dan zorgwekkend.

Vooral de situatie in Griekenland is een ramp. Een begrotingstekort van ruim 12 procent van het bruto binnenlands product, een overheidsschuld die volgend jaar hoger zal zijn dan die van Italië en de duurste vergrijzing. Het land is volledig afhankelijk van scheepvaart, toerisme en een heel klein beetje export van voedsel en textiel. Veel is dat niet. In het laatste Competitiveness Report van het World Economic Forum staat Griekenland op plaats 71, achter landen als Botswana en Kazachstan. Een staatsfaillissement is geen fantasie.

In zo'n worstcasescenario zijn andere Europese landen niet verplicht te helpen. Toch verwacht bijna iedereen dat de probleemkinderen niet alleen in de kou staan. Maar is dat ook echt zo? Met amper 3 procent van het bbp van de muntunie is de Griekse economie eigenlijk verwaarloosbaar voor het monetair beleid van de Europese Centrale Bank. Het besmettingsgevaar voor andere landen is veel kleiner dan eerder dit jaar, met de financiële crisis op een hoogtepunt. Spanje en vooral Ierland hebben zich enorm ingespannen om de overheidsfinanciën weer op een stabieler pad te krijgen.

Hoe hard het ook klinkt, nu is het moment rijp voor Europese beleidsmakers om een voorbeeld te stellen. Te vaak hebben Griekse regeringen de andere landen belazerd. Gesjoemel met begrotingsstatistieken. In 2003 was de Griekse regering de aankoop van 45 straaljagers vergeten en nog iets later bleek dat Athene bij nader inzien de Europese begrotingsregels al sinds 2000 grandioos had geschonden. De recente verdubbeling van het begrotingstekort voor 2009 na herziening was de druppel. De Europese Commissie en de andere landen van de eurozone roepen Griekenland al jaren op om de publieke sector te hervormen, de overheidsfinanciën onder controle te krijgen en de loonstijging te beperken. Het bleef roepen in de woestijn. Nu regelt de markt het zelf. Oplopende rentekosten door hogere spreads dwingen Griekenland tot bezuinigen en hervormen. Met of zonder staatsfaillissement, met of zonder steunpakket van het Internationaal Monetair Fonds of de EU, de komende jaren worden heel zwaar.

Er zijn zeker al Europese ministers die Griekenland stiekem het liefst uit de monetaire unie zouden willen gooien. Dat kan helaas niet. Maar met doortastend en stevig optreden kan in ieder geval een ding duidelijk worden gemaakt: liegen loont niet.

Deze column verscheen eerder in het dagblad "De Tijd"