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.

Letter from Brussels - Scheinzwerg

In Brüssel ist Jim Knopf kein Unbekannter. Ganz nach dem Vorbild des Scheinriesen Herrn Tur Tur, der immer größer wird je weiter man sich von ihm entfernt, hat man ein neues Phänomen entdeckt: den Scheinzwerg. Die Probleme des kleinen Inselstaates Zypern werden nämlich größer, je näher man sich an sie heran wagt.

Letztendlich wird es keine Zweifel geben: der Zypern wird bald unter den Rettungsschirm schlüpfen. Eine finanzielle Rettung Zyperns muss vor allem dem angeschlagenen Nachbarn Griechenland helfen. Ein Bankrott Zyperns oder seiner Banken würde griechische Banken weiter in den Abgrund ziehen.

So einfach ist die Rettung jedoch nicht. Im Augenblick versuchen europäische Politiker noch allen weis zu machen, dass eine Beteiligung des Privatsektors nicht zur Diskussion steht. Das Versprechen, dass der griechische Schuldenschnitt einmalig war, soll aus Angst vor neuer Ansteckungsgefahr nicht gebrochen werden. Es wird schwer, dieses Versprechen nicht zu brechen.

Mit dem im Raum stehenden Rettungspaket von 17 Milliarden Euro schnellt die zyprische Staatsschuld auf 180% vom BIP. Den griechischen Schuldenschnitt gab es bei einer Schuldenquote von 170%. Politisch wird es auch nur schwer zu verkaufen sein, dass der Finanzsektor Zyperns, der den Verdacht der Geldwäsche noch nicht widerlegen konnte, nur mit Steuergeldern gerettet wird. Letztendlich würde eine zyprische Rettung ohne Gläubigerbeteiligung auch gegen den aktuellen europäischen Trend gehen: In den Niederlanden gab es gerade eine Bankenrettung mit Privatbeteiligung und auf europäischer Ebene wird schon lange über einen Bankenabwicklungsmechanismus gesprochen, bei dem Banken, Aktionäre und Gläubiger erst selber zur Kasse gebeten werden sollen. Schwer vorstellbar, dass genau bei Zypern jetzt eine Ausnahme gemacht wird.

Herr Tur Tur bei Jim Knopf wird am Ende ein lebendiger Leuchtturm für Lummerland. Zypern könnte das Zeichen setzen, dass europäische Rettungsaktionen nicht nur mit öffentlichem Geld finanziert werden.

Dieser Artikel erschien in einer leicht veraenderten Version in der letzten "Euro am Sonntag".

German GDP drops 0.6% QoQ in 4Q 12

Contraction confirmed. As expected, the German statistical agency just confirmed the biggest contraction of the German economy since Q1 2009. The economy contracted by 0.6% QoQ in the last quarter of 2012, slightly more than expected. Detailed components will only be released next week but according to the press statement of the statistical agency, construction, investment and, above all, exports dropped in the fourth quarter, while private and public consumption increased.


With increased uncertainty stemming from the euro crisis and the global economic cooling in the second half of the year, the German economy has finally lost its invincibility. Looking ahead, however, there is increasing evidence that the economy should pick up speed again very quickly. Confidence indicators have improved over the last three months and this new optimism is not only wishful thinking. The increase of new orders is again feeding the economy’s industrial growth engine. Moreover, the industrial safety net of filling order books and inventory reductions has improved, boding well for industrial production in the months ahead. Finally, if the lower-risk environment continues, record-low interest rates should support an investment rebound, contributing to growth in 2013.

All in all, even if today’s numbers are disappointing, they are no reason to start singing the blues on the German economy. The contraction should be a temporary gaffe rather than a new worrying reality.

Opvoeden van ongeliefd kind

Hij lijkt de jongste tijd een beetje op het ongeliefde of nooit gewilde kind, onze euro. Is hij te zwak, dan roept bijna iedereen dat het einde van de monetaire unie nabij is. Is hij te sterk, dan roept bijna iedereen dat de export en daarmee het herstel van de eurozone in de kiem worden gesmoord. Wat er ook gebeurt, de euro kan het blijkbaar nooit goed doen. Ook nu weer. In enkele maanden tijd is de euro veranderd van een bedreigde in een bedreigende specie. Voor sommigen kan een sterke euro juist nu een zegen zijn.

Inderdaad, de koers van de euro is de afgelopen maanden flink gestegen. Vergeleken met het gemiddelde van 2012 is de euro zo'n 5 procent geapprecieerd ten opzichte van de dollar.

Het verrast dan ook niet dat het gejammer over de sterkere euro weer is begonnen. Het staat blijkbaar op de to-do-lijst van elke Franse president om minstens één keer per ambtstermijn de onafhankelijkheid van de ECB ter discussie te stellen en over een te hoge wisselkoers te klagen.

De negatieve gevolgen van de sterkere euro zijn wel nog te overzien. Volgens economische modellen kan de appreciatie tot nog toe de groei in de eurozone dit jaar met 0,1 tot 0,2 procentpunt verlagen. Dat is niet veel. Interessant daarbij is dat de gevolgen voor de diverse eurolanden zeer verschillend zijn. De periferielanden Spanje en Portugal worden nauwelijks geraakt door een sterkere wisselkoers. Ongeveer 60 procent van hun export gaat naar andere eurolanden. In Italië en Frankrijk kan de sterke euro veel meer pijn kan doen. Beide landen zijn relatief open en hebben zich de afgelopen jaren uit de internationale markten geprijsd. Veel Italiaanse bedrijven konden niet standhouden tegen de directe concurrentie uit China in de textielindustrie. De Franse bedrijven concurreren op de wereldmarkten vaak met de Duitsers. En terwijl de Duitse bedrijven door hervormingen, kwaliteitsverbeteringen en loonmatigingen een bijna onverwoestbare internationale vraag hebben gecreëerd, ligt de Franse exportindustrie bijna in as.

Alle periferielanden hebben door de pijnlijke hervormingen hun achterstand in concurrentiekracht ten opzichte van Duitsland gedeeltelijk ingehaald, maar in Frankrijk en Italië is helemaal niets gebeurd. Een sterkere euro brengt deze structurele problemen nu naar boven. Frankrijk zou er goed aan doen niet te veel aandacht te besteden aan onzinnige afleidingsmanoeuvres die toch niet werken. Het is de hoogste tijd om de hand in eigen boezem te steken en eindelijk de 'home made' problemen aan te pakken en structurele hervormingen in gang te zetten.

Misschien moeten de eurolanden een van de moderne opvoedboeken voor ouders lezen. Daarin staat duidelijk dat ouders ook naar zichzelf moeten kijken en veranderingen niet altijd van het kind moeten verwachten. Ongeliefd of niet.

Deze column verscheen vandaag in het Belgische dagblad "De Tijd"

ECB meeting - Mario's magic words

As expected, the ECB kept interest rates on hold. ECB president Draghi successfully tried to talk down the euro exchange rate and opened the door for possible policy action.


As regards the macro-economic assessment, the ECB’s view remained broadly unchanged. The weakness of the Eurozone economy at the end of last year and beginning of this year is still acknowledged. The economy is still expected to recovery gradually in the second half of the year. Nevertheless, risks to the economic outlook are still to the downside. As regards inflation, the ECB continues to see risks to the outlook for price developments to be broadly balanced. However, the ECB now expects headline inflation rate to drop below 2% somewhat earlier than last month. Interestingly, ECB president Draghi added a new downside risk for price stability: the appreciation of the euro exchange rate.

Ahead of today’s meeting, market participants had been focussing on two special topics: the latest appreciation of the euro exchange rate and recent comment by French president Hollande and last night’s decision by the Irish government to liquidate the Anglo Irish Bank. As regards the Irish decision, it seems as if the ECB wants to buy time. According to Draghi, the ECB only took note of the Irish decision but did not decide on how it would treat any replacement of the promissory note with a basket of bonds.

The stronger euro had been the hot topic in financial markets during the last days and weeks. French president Hollande had added oil to the fire earlier this week, calling for a more active and common exchange rate policy. Draghi countered the issue elegantly. Contrary to his predecessor, Draghi did not strike a full blow towards politicians but just stressed the ECB’s independence. Rightly so. In fact, while the European Treaties give politicians the right to come up with “general orientations” for exchange rate policy, these orientations cannot bind the ECB if it considers them to be inconsistent with price stability. Moreover, the Treaties prohibit the ECB to take instructions from governments.

Draghi’s biggest challenge was to show his magic skills of verbal interventions and to talk down the euro exchange rate. He succeeded. Adding the stronger euro to the downside risks for price stability opened the door for new policy action if the euro strengthens further and starts to weigh on the growth and inflation projections. Moreover, Draghi did not get tired of stressing the ECB’s accommodative monetary stance. He even implicitly voiced his dissent with monetary policies too obviously aimed at weakening the currency, sending an implicit signal that the ECB would not be happy with a further, not fundamentally-driven, appreciation of the euro.

At least for now, it is mission accomplished. Mario Draghi is on the best way to become the new central bank Maestro, being able to talk the talk without having to walk the walk.

German IP stabilises in December

Industrial stabilisation continues. German industrial production increased by 0.3% MoM in December, from a downward revised -0.2% MoM in November. On the year, industrial production is still down by 1.1%. The increase was driven by production of consumer goods (+3.9% MoM) and capital goods (+1.9% MoM). Despite the relatively mild December weather, production in the construction sector fell sharply by almost 9% MoM.


Despite today’s slight improvement, industrial production in the last three months of 2012 disappointed and confirms the contraction of the entire economy by around 0.5% QoQ in 4Q12. Nevertheless, even if the headline figure is no reason to become overly enthusiastic, today’s industrial production data indicate that the industrial slowdown has come to an end. In fact, it provides further evidence that the outlook for the German economy has brightened.

Confidence indicators have improved over the last three months and this new optimism is not only wishful thinking. The increase of new orders is again feeding the economy’s industrial growth engine. Moreover, the industrial safety net of filling order books and inventory reductions has improved, boding well for industrial production in the months ahead. Finally, if the lower-risk environment continues, record-low interest rates should support an investment rebound, contributing to growth in 2013.

All in all, this week’s industrial data send two important messages. A good and a bad one: the first contraction of the German economy since 1Q 09 has been confirmed but the rebound has already started.

From endangered to danger? Can the strong euro choke off the recovery before it has even started?

Sometimes the euro looks like the unwanted or unloved child that can never get it right. A weakening of the euro is often regarded as a harbinger of tension and fading confidence in the entire monetary union. At the same time, a strengthening euro is quickly condemned as harmful to growth. At the current juncture, the initial relief associated with the latest euro strengthening has cleared the way for a more sceptical view on the exchange rate. There is now a fear that the recently endangered euro could itself become a danger for the Eurozone.

Here is the link to my latest ING research note: ING: From endangered to danger?