THE EUROPEAN CRISIS: A VIEW FROM THE SOUTH

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1 THE EUROPEAN CRISIS: A VIEW FROM THE SOUTH IEA and BCU Roundtable on Capital Flows, Capital Controls and Monetary Policy Andreu Mas-Colell Minister of Economy and Knowledge Government of Catalonia December 2013

2 I. Europe 2

3 The distinctive aspect of the European crisis is that it is a sovereign debt crisis. It is a sovereign debt crisis because of the Euro: a currency without a sovereign. The Euro: a project driven more by political commitment than by economic logic. Politics or economics: which side will prevail? 3

4 The case for political commitment The European elites are highly committed to the Euro. The magnitude of the failure would be devastating for the ideal of a Europe with weight in the world. An interpretation of what is happening is that the Eurozone is simply moving in the direction that the goal of economic consistency indicates it should move. In that sense, what we see was in the script of the Euro. It is a pity that the catalyst for advancement should be a crisis, but that is how the world turns. The ECB is a success. The cost of exit by a country may be quite high. Perhaps it was not a good idea to get in, but the reversibility of the decision is doubtful. In summary: the break-up of the Euro will for sure not happen in the short-tomedium run 4

5 The case for economic logic. Short-term threats Economic Governance: It is too weak for the magnitude of the crisis. In particular, the policy of doing at all times whatever is minimally necessary for dodging out of current difficulties (but no more) is prone to accidents (Cyprus?, Portugal Supreme Court?, etc.). Current fiscal policies are dominated by the moral-hazard argument. As a consequence they are excessively front-loaded and are not helping to overcome recessionary trends in the South (and some risks in the North?). They are increasingly perceived in the South, even by those that recognize the virtues of fiscal discipline, as an overdose of (necessary) medicine. Worse still, its proponents in the North are viewed as self-serving by the South, all of which breeds resentment. The designed horizon for the Eurozone banking union (no transfers for the bank resolution mechanism, no common deposit insurance mechanism) is too timid and prone to geographical segmentation (Cyprus as vaccine?). 5

6 European banking union The official goals of the banking union are: To break the cycle in which banks and nations compound each other s financial strains. To avoid negative spill-over effects across borders. To level the playing field for European lenders and facilitate the free flow of capital and liquidity across borders (avoid Balkanization of banks). And it is clear that additional objectives include: To prevent a repetition of the financial meltdown that started in To coordinate the liquidation of cross-border banks. To protect taxpayers from the banks risk. To avoid the zombie banks experience of Japan in the 90s. 6

7 European banking union Agreements The Single Supervisory Mechanism (SSM): the ECB is to monitor EU s 130 largest banks in the 18 Eurozone states. Before the ECB starts supervising Europe s banks, all 130 banks need to undergo a stress test and have their balance sheets checked for risky business and non-performing loans. 7

8 European banking union Unresolved issues The Single Resolution Mechanism (SRM): joint liquidation of bankrupt banks. Who decides which banks to liquidate and which banks to rescue? The French proposal is that the EU Commission acts as liquidation authority because of its rapid response capability. But Germany wants national supervisory authorities to have the last word on the fate of banks. France, the Commission and the ECB all agree on the need for a single resolution fund while Germany supports a network of national funds. The scope of the banking sector placed under the framework: Germany calls for the supervision of only the top 130 banks to avoid ceding sovereignty over its local banks. Pooled deposit guarantees. Due to Germany s reluctance to risk mutualization, it has been abandoned in favor of pursuing an agreement on a common network of national deposit-guarantee schemes. The banking union and the dominance of the ECB may put the influence of the City at risk, causing concern in the UK. 8

9 Recessionary trends in Europe GDP (% change in volume) Unemployment rate (%) Source: European Commission 9

10 The case for economic logic. Long-term threats An Eurozone persistently dualized in terms of growth and interest rates will not stabilize. A uniformly stagnant Europe could stabilize, but this is hardly desirable! 10

11 The gap between yields required by sovereign debt in Northern and Southern countries is closing 35 Long-term interest rate (%) Germany Ireland Greece Spain Portugal Source: ECB. 11

12 The case for economic logic. Long-term threats An Eurozone persistently dualized in terms of growth and interest rates will not stabilize. A uniformly stagnant Europe could stabilize, but this is hardly desirable! Some degree of mutualization will be necessary (the EU budget is 1% of European GDP. There are no Eurobonds, Europensions, Euroinsurance for deposits or Euroinsurance for unemployment) but very hard to achieve. Germany is adamantly against it. A much higher degree of political union (elected President?) may be the necessary premise for mutualization. Officially, Germany is not hostile to such a development. 12

13 A comparison: the EU and the US Federal Government Europe (2011) USA (2011) Population: 502,5 Million Population: 311 Million EU-27 GDP: 17,7 $Trillion US GDP: 15 $Trillion EU budget: 177 $Billion US Federal budget: 3,6 $Trillion Budget as percentage of GDP: 1% Budget as percentage of GDP: 24% 13

14 Are Southern economies sustainable? Southern economies are highly indebted and aloofness of the financial markets is still high. Despite recent adjustments, competitiveness is lower than in the North. Risk premiums are high in the South. Imposing an overly fast-paced consolidation is counterproductive (this is what Merler and Pisani-Ferry refer to as Self-defeating austerity). 14

15 II. Spain 15

16 Difficulties Fall in GDP is bottoming out (no growth): 2012 annual figure: - 1,6% 2013 quarterly Q2 figure: - 0,1% 2013 quarterly Q3 figure: +0,1% Persistent unemployment: 2012 Q4 figure: 26,02% 2013 Q3 figure: 25,98% 16

17 % Annual change The bursting of the real estate bubble Real GDP growth and investment in construction Real GDP growth Investment in construction Source: National Institute of Statistics of Spain. 17

18 Difficulties No growth (2013 quarterly Q3 figure:+0,1%) and persistent unemployment (2013 Q3 figure: 25,98%). Private indebtedness is very high (208,3% of GDP in Q2 2013), while public indebtedness, which was at a low level at the start of the crisis, has now reached 93,4% of GDP. As a consequence neither public nor private demand are growth forces. Financial sector restructuring (with European help) is advanced but not yet over. The economy is credit-starved. Mortgages and foreclosures constitute a dramatic social problem (less well resolved, in terms of social protection, than unemployment) and a serious risk factor for the financial sector. The risk-premium situation has improved considerably but it is not yet out of the woods. A number of reforms are being implemented, but additional efforts will be necessary in pensions and the public sector (including health). 18

19 Favorable factors The Central government has an absolute majority (in order to implement policies is better this than the situation in Italy). The decline of real estate values may (?) be bottoming up. 19

20 House-price evolution US Spain 20

21 Favorable factors The Central government has an absolute majority (in order to implement policies is better this than the situation in Italy). The decline of real estate values may (?) be bottoming up. The economy is gaining competitiveness, not only because of an internal devaluation but also because there was more than partying during the years of the bubble. The export (including tourism) and balance of payments performance is excellent. 21

22 External competitiveness is improving 115,0 Labor cost index, nominal value, (2008=100) 110,0 105,0 100,0 95,0 90,0 85,0 Eurozone Spain Source: Eurostat. 22

23 External imbalance is stabilizing 4000 Trade balance (monthly, M ) Spain Source: INE. 23

24 Favorable factors The Central government has an absolute majority (in order to implement policies is better this than the situation in Italy). The decline of real estate values may (?) be bottoming up. The economy is gaining competitiveness, not only because of an internal devaluation but also because there was more than partying during the years of the bubble. The export (including tourism) and balance of payments performance is excellent. Perhaps too many infrastructures were built, but they are there. There is a positive outlook for 2014, which might indicate that the favorable factors are stronger than the difficulties. 24

25 International institutions regularly review Spanish macroeconomic performance EU Commission (April 2013): Macroeconomic Imbalances Procedure Although adjustment is taking place, Spain is still experiencing excessive macroeconomic imbalances: high debt level, high unemployment and banking sector restructuring. Main recommendations: Completion of the recapitalization and restructuring of the banking sector. The credibility of the fiscal adjustment would be reinforced by basing consolidation on structural measures. Strengthen competition in product and services markets (including network industries). Improve the business environment. Lend support to the internationalization of companies. Comprehensive review of the impact of the 2012 labor market reform and enhance active labor market policies. 25

26 International institutions regularly review Spanish macroeconomic performance EU Commission (November 2013): Review Financial Assistance Program Recent data points to a stabilization of the economy. Consumer and business confidence has been on the rise. Unemployment appears to be stabilizing. The fall in GDP appears to be bottoming out. The current account is now in surplus. Cost competitiveness has been recovering. Private debt ratios are slowly declining. Main recommendations: Further strengthening of public finance management. Boost active labor market policies. Maintain the pace of structural reforms. 26

27 International institutions regularly review Spanish macroeconomic performance IMF (November 2013): Report Financial Sector Reform The clean-up of banks balance sheets under the financial sector program has significantly bolstered the system s capital and liquidity. The risk premium on Spain s 10-year sovereign bond eased about 65 basis points. Bank wholesale borrowing costs fell even faster. Equity markets have been similarly bullish, with the IBEX rising 23 percent. Credit conditions remain tighter than in the euro area core. Further substantial structural adjustment will likely be necessary to stabilize the debt-to-gdp ratio over the medium term. Significant overhang of supply remains in the housing market, which may keep downward pressure on prices in the near term. IMF staff project a moderate pace of recovery over the medium term. Uncertainty is large, given the significant potential for both vicious and virtuous cycles to take hold 27

28 Thank you very much! 28