After the latest EU crisis meeting it is clear that politicians are responding to the eurozone sovereign debt crisis through incremental improvements, according to Fitch Ratings. It seems that a ‘comprehensive solution’ to the current crisis is not on offer.
This summit demonstrated strong political support for the euro, and that its members are putting in place the institutional and policy framework for a more viable eurozone and ultimately greater fiscal union. But taking the gradualist approach imposes additional economic and financial costs compared with an immediate comprehensive solution. It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond, until the region is able to sustain broad economic recovery.
In the short term we predict a significant economic downturn across the region. The eurozone faces intense market pressure, which is triggering loss of business and consumer confidence, and weak industrial activity and retail sales. Fitch’s forecast of 0.4% eurozone GDP growth next year and 1.2% in 2013 would be significantly higher if there was a comprehensive solution to the crisis. The lack of a comprehensive solution has increased short-term pressure on eurozone sovereign credit profiles and ratings.
The latest EU Summit, like others before it, has resulted in some positive developments. There is an extra €200bn of funding for the IMF, the European Stability Mechanism (ESM) has been brought forward, and there has been policy change on private-sector involvement in any future sovereign crisis. As with all summits there is execution risk.
The extra resources for the IMF are welcome but it is not clear how and under what circumstances they would be deployed. The move away from requiring private sector involvement (PSI) as a condition for ESM programmes is clearly positive for bondholders. The European Commission (EC) said it will “strictly adhere to the well-established IMF principles and practices.” PSI has been a feature of past IMF programmes, but the fund sets out to attract private capital to sovereigns and can be expected to use PSI as a last rather than a first resort.
Separately, the European Central Bank (ECB) also announced changes to its repo schemes that will aid bank liquidity, such as three-year liquidity lines and looser collateral requirements for structured finance. This could be positive for eurozone sovereigns if it eases pressure on them to introduce or re-activate bank debt guarantee schemes.
The summit’s conclusions show a longer-term desire to move towards some form of fiscal integration in return for enforced fiscal prudence. Fitch believes that most of the vulnerable eurozone countries are already implementing aggressive austerity programmes, and some are already changing their national constitutions. It is too early to judge how effective the fiscal compact will be due to the uncertainty regarding how it will be implemented.
Fitch still believes the ECB, either directly through its sovereign bond purchase programme or indirectly by allowing the EFSF/ESM to access its balance sheet, is the only truly credible ‘firewall’ against liquidity and even solvency crises in Europe.
Hopes that the ECB would step up its actions in support of its sovereign shareholders as a quid pro quo for institutional and legal changes that gave the ECB greater confidence in the long-run commitment of eurozone governments to fiscal discipline appear to have been misplaced.
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