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Beyond Greece, Eurozone Has Other Achilles’ Heels

April 29, 2010 14 comments

By Marquis Codjia

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The current brouhaha over Greece’s budgetary mischance and its alleged adverse effects on Europe are an epochal episode in the history of the emergent European economic zone, but these are not the decisive areas where decision-makers, including political leaders and financial markets participants, should pay heed.

Greece’s debt pains would ultimately be resolved, because Eurozone behemoth Germany will strategically come in line with its continental peers; also, supranational channels – such as the European Central Bank and the IMF – will be coerced into using their balance sheets to provide liquidity to cash-strapped Hellenes.

The real fear presently is contagion – avoiding that the ambient financial pandemonium metastasizes into other economically comatose countries within the union. If any of these countries, clustered under the unflattering acronym of P.I.G.S. (Portugal, Italy, Greece, Spain), is downgraded by rating agencies – as was recently the case for Spain and Portugal who lost a few notches, the potential bailout costs and risk premia will rise stratospherically.

Eurozone leaders should swiftly settle Greece’s problems because of perception risks. No doubt the country is a financial and geostrategic dwarf (2% of Eurozone GDP and no major federal institution headquartered). Plus, other ‘weakest links’ such as Spain and Italy possess far greater self-financing capacities and have a different debt structure (domestically held vs. 95% of Greek debt held by foreigners). Notwithstanding, if trans-European perception is that Eurozone will not show geo-economic solidarity vis-à-vis its members in times of uncertainty, then the concept of political union loses its relevancy, and economic agents, including financial markets, will certainly reflect their despondency by driving the single currency lower.

Broadly, other systemic inefficiencies continue to thwart progress within the Eurozone.

First is the lack of a clear political structure in the federation. European leaders, particularly those from prominent countries (UK, Germany, France), seem at this point more content with a federal hierarchy replete with political figures (preferably from minor countries) who pose no leadership threat to them, and a plethora of bureaucratic institutions filled with functionaries picked on an unwritten pro-rata rule to satisfy member states. This strategic stance of an elusive political union grounded in an economic zone is antithetical to the very concept of federation that subtended the initial EU agreement.

To illustrate this, let’s consider a simple example: whom would current U.S. President Barack Obama or China Premier Wen Jiabao negotiate a strategic partnership with if either leader needs a European counterpart? Would they call upon the current President of the European Commission José Manuel Durão Barroso? Or the current President of the European Council Herman Van Rompuy? Or the current (6-month rotating) President of the Council of the European Union José Luis Rodríguez Zapatero? Or EU heavyweights French President Nicolas Sarkozy or German Chancellor Angela Merkel? Or a combination of all of these leaders?

Second, the lack of a clear, single political leadership begets an absence of a uniform socio-economic agenda in the union. It seems as though European leaders want the pros of economic integration, but abhor its cons altogether without attempting to minimize or obliterate them. EU citizens must define what the Eurozone stands for: is it a free-trade area, similar to NAFTA (North American Free Trade Agreement) or ECOWAS (Economic Community of West African States), where partner countries retain their political, economic and social independence, and can compete against each other? Or is it a political and economic union steered by broadly uniform national social policies, similarly to a single country? Or is it, rather, something in between, or neither?

Third, European Central Bank’s powers must be broadened beyond price stability. Unlike the U.S. Fed, the bank’s only primary mandate at the moment is to keep inflation low, with other objectives subordinate to it. The ECB should intervene further in the regional economy, and help avoid systemic disequilibria if need be. In sum, the institution should be allowed to use its gigantic reserves to calm jittery markets in times of uncertainty, among other roles.

Fourth, Eurozone membership should be reviewed; this includes not only the admission process, but also membership conditions and stipulations for exclusion. Understandably, the political undertones of this process call for some diplomatic verbiage, but overall, countries seeking membership in the privileged “Club Euro” must meet stringent criteria, and such criteria should be thoroughly enforced. The current Stability and Growth Pact, which aims to limit budget deficits and debts, is a good start but the ineffective control scheme around it permitted the kind of statistical fraud that Greece authored when seeking admission nearly a decade ago. In sum, sound economic fundamentals and strict governance rule, in addition to geography, should be the rationale for co-opting new members into the Eurozone.

Finally, the EU enlargement process should pay special attention to two key dossiers: U.K. and Turkey. The argument here is not in favor of a quick admission (in Turkey’s case), but for a clearer acceptance framework, more effective than the current 31-chapter “Acquis Process”.

Both dossiers are complex and politically charged, but their quick resolution will do more good than harm to the EU. Turkey has many woes (human rights concerns, Cyprus dispute, perception of Islamism despite the country’s secularism, business regulation, etc.), but its advantages are also interesting. It is 16th largest GDP in the world – per IMF’s 2009 ranking, outpaced in the Eurozone only by Germany, U.K., France, Italy and Spain. This means that, out of the current 27 EU members, it ranks 6th on GDP measurement. The country is geographically larger than any EU member and its ca. 73 million citizens are outnumbered only by Germany’s ca. 82 million; this may open up potential new markets for growth-seeking EU businesses. Politically, Ankara is an important geostrategic ally of the West and a member of such key organizations as G-20, OECD and NATO.

As for the U.K., a current EU member that opted out of the Eurozone, its Labor Party-led government defined in the late 1990s five economic tests that must be met prior to adopting the Euro as national currency, either via parliamentary ratification or referendum. Euro adoption remains a domestic hot button issue and thus may not be addressed for many years. But, it’d be interesting to see how politicians and business leaders will react once the euro reaches parity with, or gradually outpaces, the pound sterling. So far, the euro has risen 65% vs. the pound, from a low of 57 cents in 2000 to 94 cents a decade later, briefly nearing parity late in 2008 (.98 in December 2008).

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Germany and its Greek dilemma

February 10, 2010 7 comments

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The general mood at 1, Willy-Brandt-Straße in Berlin was tense lately. The German chancellery’s headquarters, one of the world’s largest executive buildings – 8 times the size of the White House – is filled with an army of thousands of civil servants, mainly preoccupied with pending domestic issues, from unemployment and economic growth to fiscal fraud enforcement.

However, the question which worries Angela Merkel, the German Chancellor, and her close advisers more is the financial chaos in Greece and its consequences for the Eurozone.

Considering the solidity of its economic fundamentals, its excellent score with credit rating agencies, and a discipline in the management of its federal budget akin to the precepts of the best Wehrmacht strategists, Germany was able to resist the deleterious effects of the crisis better than other European counterparts.

Berlin is not only Europe’s superpower by many standards; it remains the continent’s fundamental economic engine. This position poses Germany a dilemma because its interdependence with other countries within the Union (export-based economy) and the absence of tariffs (Schengen Accords) force it to lend a hand to its neighbors.

In short, Germany must engineer a Marshall plan to enliven the weakest links in the federation’s economic chain if it does not want to be a collateral victim in the long term.

Angela Merkel and federal Finance Minister Wolfgang Schäuble remained for a long time unwilling to help weakened economies within the Union because they suspected that some nations use Europe as a conduit to vent their domestic troubles.

The lack of trust explains Berlin’s reticence to use the European Central Bank and the Bundesbank as principal bailout sources, preferring the IMF and other transnational channels so that financial risks can be spread over a larger spectrum of investors and countries.

German analysts and financial markets emphasize that Greece has not been a model of economic management of late. Far from being a geostrategic dwarf like Iceland, Greece is a solid economy (primarily based on tourism and the maritime sector) ranked 26th on the IMF list (Country GDP in 2009).

But the surreal fact remains that the country, currently under the premiership of American-born Geórgios Papandréou, was found guilty of statistical fraud when it applied for EU membership.

Greek leaders must tackle seriously current public deficit and debt payment problems, and upcoming fiscal tightening measures will only increase social unrest.

Other countries within the Old Continent, currently grouped under the less flattering P.I.G.S. acronym, have a similar prognosis. They are Portugal, Italy, (Greece), and Spain and have economies hard hit by the real-estate crisis, a climbing unemployment rate, a fall in industrial productivity and scores of outsourcing decisions by private firms.

European leaders will undoubtedly react to avoid a domino effect potentially deleterious for the rest of Europe. Many options are available to them, including a direct ECB assistance to Greece, a partial repurchase of Greek debt by the central bank, subsidies from transnational institutions like the IMF, and an increase in protectionist measures to stop the socio-economic crisis (e.g.: shoe war with China).