Eurozone leaders met at a summit in Brussels on 28 and 29 June. Expectations ahead of the summit were low that any significant progress would be made on supporting eurozone banks and governments, on achieving more effective bank regulation or stimulating economic growth.
For once, EU leaders surprised markets by reaching a more comprehensive agreement than anticipated. The agreement has five key elements:
1. The use of funds from the soon-to-be launched eurozone bailout fund, the European Stability Mechanism (ESM), to lend to banks directly. Previously, funds had been made available to national governments to lend to their banks. This, however, increased the debts of the national governments, such as Spain, which made it harder for them to meet deficit and debt targets.
2. The setting up of a new banking supervisory body to impose common standards, such as capital adequacy requirements, on banks across the eurozone.
3. The use of the eurozone bailout fund to buy government bonds on the secondary market, provided governments are sticking to agreed deficit reduction measures. This would help to reduce interest rates on government bonds in countries such as Spain, Italy and Greece, currently having to pay interest rates 5 or 6 percentage points above those on German bonds.
4. A €120bn growth package to target EU money at small businesses, youth unemployment and infrastructure improvements. Most of the money would be from existing funds, such as EU Structural Funds, which are currently unused. There would be some additional funds, however, including €10bn to boost the lending capacity of the European Investment Bank.
5. A 10-year ‘roadmap’ towards greater fiscal union, including the creation of a eurozone treasury, which could limit overall spending by national governments.
Generally the agreement has been greeted positively, with stock markets in the eurozone and across the world rising significantly. But will the measures be enough to reassure investors over the coming weeks? Will they cure the problems of the eurozone or are they just one more, albeit larger, sticking plaster?
The following webcasts, podcasts and articles look at the agreement and the resulting prospects for the eurozone.
Webcasts and podcasts
Eurozone bends the rules to save single currency euronews (29/6/12)
Markets Like Euro Crisis Deal, Merkel Defensive Associated Press (29/6/12)
Eurozone crisis: ‘Breakthrough’ at summit BBC News, Gavin Hewitt (29/6/12)
EU summit outcome exceeds – low – expectations euronews (29/6/12)
Italy and Spain are main beneficiaries after EU summit euronews (30/6/12)
EU bank aid deal ‘better than expected, worse than needed’ euronews (29/6/12)
New eurozone deal ‘not enough’ BBC Today Programme, James Shugg (29/6/12)
Eurozone: ‘Massive concession’ from Angela Merkel BBC Today Programme, Gavin Hewitt and Robert Peston (29/6/12)
Eurozone bank bailout deal throws lifeline to Spain and Italy Guardian, Ian Traynor and Phillip Inman (29/6/12)
Spain lifeline after EU allows direct access to eurozone bailout funds Guardian (29/6/12)
Less disunion The Economist, Charlemagne’s notebook (29/6/12)
Eurozone agrees on bank recapitalisation BBC News (29/6/12)
Merkel defends compromise deal on eurozone banks BBC News (29/6/12)
A first, tentative step to salvation for the eurozone Independent, Leading article (29/6/12)
Analysis – Sharing a vision may be Europe’s biggest challenge Reuters, Alan Wheatley (3/7/12)
Eurozone bank agreement welcomed FT Adviser, Rebecca Clancy & Bradley Gerrard (2/7/12)
The real victor in Brussels was Merkel Financial Times, Wolfgang Münchau (1/7/12)
Finns, Dutch cast first doubt on EU summit deal EurActiv (3/7/12)
A Euro deal from Brussels BBC News, Stephanie Flanders (29/6/12)
Conclusions of the European Council (28/29 June 2012) European Council (29/6/12)
- What are the advantages of the ESF lending to banks directly? Are there any problems associated with the proposal?
- To what extent will the measures solve the problems of the eurozone? What else might need to be done?
- Are there any potential moral hazards contained in the proposals and how are they likely to be tackled?
- Explain the concept of ‘seniority’ in the following statement: “the debt owed by Spain to the EFSF, if and when it is transferred to the ESM, will not gain seniority”. Why might this be good for private financiers?
- If governments’ bonds are to be purchased by the ESM, what conditions are likely to be attached?
At its meeting on 26 October, the eurozone countries agreed on a deal to tackle the three problems identified in Part A of this blog:
1. Making the Greek debt burden sustainable
2. Increasing the size of the eurozone bailout fund to persuade markets that there would be sufficient funding to support other eurozone countries which were having difficulties in servicing their debt.
3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults.
The following were agreed:
1. Banks would be required to take a loss of 50% in converting existing Greek bonds into new ones. This swap will take place in January 2012. Note that Greek debt to other countries and the ECB would be unaffected and thus total Greek debt would be cut by considerably less than 50%.2. The bailout fund (EFSF) would increase to between €1 trillion and €1.4 trillion, although this would be achieved not by direct contributions by Member States or the ECB, but by encouraging non-eurozone countries (such as China, Russia, India and Brazil) to buy eurozone debt in return for risk insurance. These purchases would the form the base on which the size of the fund could be multiplied (leveraged). There would also be backing from the IMF. Details would be firmed up in November.
3. Recapitalising various European banks to shield them against possible losses from haircuts and defaults. About 70 banks will be required to raise an additional €106.4 billion by increasing their Tier 1 capital ratio by 9% by June 2012 (this compares with the Basel III requirement of 6% Tier 1 by 2015).
On the longer-term issue of closer fiscal union, the agreement was in favour of achieving this, along with tight constraints on the levels of government deficits and debt – a return to something akin to the Stability and Growth Pact.
On the issue of economic growth, whilst constraining sovereign debt may be an important element of a long-term growth strategy, the agreement has not got to grips with the short-term problem of a lack of aggregate demand – unless, of course, the relief in markets at seeing a solution to the debt problem may boost business and consumer confidence. This, in turn, may provide the boost to aggregate demand that has been sadly lacking over the past few months.
Certainly if the reaction of stock markets around the world are anything to go by, the recovery in confidence may be under way. The day following the agreement, the German stock market index, the Dax, rose by 6.3% and the French Cac index rose by 5.4%.
Eurozone crisis explained BBC News (27/10/11)
Leaders agree eurozone debt plan in Brussels BBC News, Matthew Price (27/10/11)
Eurozone agreement – the detail BBC News, Hugh Pym (27/10/11)
10 key questions on the eurozone bailout Citywire Money, Caelainn Barr (27/10/11)
European debt crisis: ‘Europe is going to have a very tough winter’ – video analysis Guardian, Larry Elliott (27/10/11)
Eurozone crisis: banks agree 50% reduction on Greece’s debt Guardian, David Gow (27/10/11)
The euro deal: No big bazooka The Economist (29/10/11)
Europe’s rescue plan The Economist (29/10/11)
European banks given just eight months to raise €106bn The Telegraph, Louise Armitstead (26/10/11)
EU reaches agreement on Greek bonds Financial Times, Peter Spiegel, Stanley Pignal and Alex Barker (27/10/11)
Unlike politicians, the markets are seeing sense Independent, Hamish McRae (27/10/11)
Market view: Eurozone rescue deal buys time FT Adviser, Michael Trudeau (27/10/11)
Greece vows to build on EU deal, people sceptical Reuters, Renee Maltezou and Daniel Flynn (27/10/11)
Markets boosted by eurozone deal Independent, Peter Cripps, Jamie Grierson (27/10/11)
Has Germany been prudent or short-sighted? BBC News blogs, Robert Peston (27/10/11)
Germany’s Fiscal union with a capital F BBC News blogs, Stephanie Flanders (27/10/11)
- What are the key features of the deal reached in Brussels on 26 October?
- What details still need to be worked out?
- How will the EFSF be boosted some 4 or 5 times without extra contributions fron eurozone governments?
- Why, if banks are to take a 50% haircut on their holdings of Greek debt, will Greek debt fall only to 120% per cent by 2020 from just over 160% currently?
- On balance, is this a good deal?
As European leaders gather for an emergency summit in Brussels to tackle the eurozone debt crisis, we consider the issues and possible solutions. In Part B we’ll consider the actual agreement.
There are three key short-term issues that the leaders are addressing.
1. The problem of Greek debt
With fears that the Greek debt crisis could spread to other eurozone countries, such as Italy and Spain, it is vital to have a solution to the unsustainability of Greek debt. Either banks must be willing to write off a proportion of Greek debt owed to them or governments must give a fiscal transfer to Greece to allow it to continue servicing the debt. Simply lending Greece even more provides no long-term solution as this will simply make the debt even harder to service. Writing off a given percentage of debt is known as a ‘haircut’. The haircut on offer before the summit was 21%. Leaders are reportedly considering increasing this to around 60%.
2. The size of the eurozone bailout fund
The bailout fund, the European Financial Stability Facility (EFSF), stood at €440 billion. This is considered totally inadequate to provide loans to Italy and Spain, should they need a bailout. France and other countries want the ECB to provide extra loans to the EFSF, to increase its funds to somewhere between €2 trillion and €3 trillion. Germany before the meeting was strongly against this, seeing it as undermining the rectitude of the ECB. A compromise would be for the EFSF to provide partial guarantees to investors and banks which are willing to lend more to countries in debt crisis.
3. Recapitalising various European banks
Several European banks are heavily exposed to sovereign debt in countries such as Greece, Italy and Spain. It is estimated that they would need to raise an extra €100 billion to shield them against possible losses from haircuts and defaults.
But there is the key longer-term issue as well.
Achieving long-term economic growth
Without economic growth, debt servicing becomes much more difficult. The austerity measures imposed on highly indebted countries amount to strongly contractionary fiscal policies, as government expenditure is cut and taxes are increased. But as the economies contract, so automatic fiscal stabilisers come into play. As incomes and expenditure decline, so people pay less income tax and less VAT and other expenditure taxes; as incomes decline and unemployment rises, so government welfare payments and payments of unemployment benefits increase. These compound public-sector deficits and bring the possibility of even stronger austerity measures. A downward spiral of decline and rising debt can occur.
The answer is more rapid growth. But how is that to be achieved when governments are trying to reduce debt? That is the hardest and ultimately the most important question.
Brussels summit: the main issues to be resolved The Telegraph (25/10/11)
EU crisis talks in limbo after crucial summit is cancelled The Telegraph, Louise Armitstead (25/10/11)
Euro zone summit likely to give few numbers on crisis response Reuters, Jan Strupczewski (25/10/11)
Factbox: What EU leaders must decide at crisis summit Reuters (24/10/11)
Hopes low ahead of EU summit Euronews on YouTube (25/10/11)
Euro crisis: EU leaders hope to reach debt plan BBC News (26/10/11)
The deadline Europe cannot afford to miss BBC News, Nigel Cassidy (26/10/11)
Why EU summit is crunch day for the eurozone BBC News, Paul Mason (26/10/11)
Southern European banks need most capital BBC News blogs, Robert Peston (23/10/11)
Will Germany insure Italy against default? BBC News blogs, Robert Peston (26/10/11)
Plan B for the eurozone? BBC News blogs, Stephanie Flanders (26/10/11)
‘No such thing as Europe’ BBC Today Programme, Stephanie Flanders and Martin Wolf (26/10/11)
Markets to eurozone: It’s the growth, stupid BBC News blogs, Stephanie Flanders (24/10/11)
Fears euro summit could miss final deal Financial Times, Peter Spiegel, Gerrit Wiesmann and Matt Steinglass (26/10/11)
Time to unleash financial firepower or face euro breakup Guardian, Larry Elliott (25/10/11)
The Business podcast: eurozone crisis Guardian, Larry Elliott, David Gow and Jill Treanor (25/10/11)
Why is Germany refusing to budge on the eurozone debt crisis? Guardian blogs, Phillip Inman (26/10/11)
- In terms of the three short-term problems identified above, compare alternative measures for dealing with each one.
- To what extent would the ECB creating enough money to recapitalise European banks be inflationary? On what factors does this depend?
- Does bailing out countries create a moral hazard? Explain.
- What possible ways are there of achieving economic growth while reducing countries sovereign debt?
- Would you agree that the problem facing eurozone countries at the moment is more of a political one than an economic one? Explain.
- What are the arguments for and against greater fiscal integration in the eurozone?