Commentary by Timothy Leon Misir (Policy and Programme Executive, EU Centre in Singapore)
8 Nov 2011 – European leaders met to decide on measures to stave off an imminent crisis in the euro zone in a meeting on 26 October that lasted till the early hours of the next morning. They agreed on a package of comprehensive measures to tackle the Greek debt and to bolster the economic governance of the single currency area. The measures though, only allow for some breathing room, as they do not restore the loss of confidence toward the euro zone that is at the heart of its malaise.
Central to the agreement is the decision to expand the European Financial and Stability Facility (EFSF) to €1 trillion, from its previous €440 billion lending capacity. Additionally, a recapitalisation of banks to the tune of €109 billion was agreed upon. To boost liquidity, banks are also to increase their capital to equity ratio to 9% by 2013. Restructuring Greek national debt, which is projected to rise to 200% of GDP by 2015, is also a priority. A 50% write down of the debt held by private investors and banks was agreed upon.
Financed by euro zone nations, the EFSF was set up to provide liquidity for faltering nations within the currency union, by guaranteeing member-state issued bonds, and through its special purpose vehicle that would buy up bonds of ailing nations. However, its lending capacity was soon revealed to be insufficient as markets turn against larger nations like Italy and Spain. The problem though, is that little has been said about where the money is going to come from.
The only member of the euro zone of the size required, and in a firm position is Germany. France, whose deficit is likely to reach 5.7% (according to the IMF) is the 2nd largest creditor nation in the euro zone. In fact, it might lose its AAA rating soon as it is mired in its own crisis – its banks are heavily exposed to Greek and Italian sovereign debt, to the tune of approximately US$53.9 billion and US$365.8 billion, and US$118.1 billion of Spanish debt (June 2011 figures, Bank for International Settlements). Currently, 10-year government bonds yield about 27-28% for Greece, 5.7% for Spain, and 6.6% for Italy, a 14-year high for the country. In view of a poorer outlook on refinancing conditions, Moody’s recently downgraded the ratings for Société Generale and Crédit Agricole, two of the country’s largest banks.
The global banking system is still over-leveraged, and little has been done to reduce high-frequency trading, control speculation and prevent future speculation bubbles that have almost brought the euro zone to its knees. They were at the core of the global financial and sovereign debt crises and must be kept in check to prevent financial contagion.
Credit is likely to become more scarce and expensive with the new banking rules in place. A credit squeeze is likely, as banks cannot lend more money, or begin to hoard cash, making loans more expensive and reducing the number of inter-bank loans that keep the global financial system functioning. The impact on the real economy would be severe if businesses slowed or stalled because of the credit crunch. The plan also assumes that it will be able to raise money from emerging economies. Countries like China, Saudi Arabia and the like have thus far sustained the neoliberal capitalist model in the midst of the crisis, but on what conditions they will continue to do so has yet to be determined.
The threat of a widespread debt default continues to put Asian financial markets at risk, though the full extent of their exposure to the European bond markets is not known. Here, the problem is less with direct investment and more with credit default swaps. Greece’s €400 billion debt is no longer the only problem, as markets are beginning to focus on Italy, which has €2 trillion in debt. There are fears that if Italy falls, France and the rest of Europe will soon follow. The problem is that markets are driven by confidence, and at the moment, many questions still remain, especially with regards to the health of the single currency, and its weaker members.