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It Is Time for Fiscal Consolidation, Says the G20

2 July 2010

It was under the theme of “Recovery and New Beginnings” that the leaders of the G20 countries met in Toronto, on 27-28 June. It was intended to be the first session that would mark the G20 role as “the premier forum for our international cooperation” yet the results from the summit were not particularly convincing. Differences still remained on what the G20 members should do to ensure that the fragile economic recovery would not stall. The EU in the face of sovereign debt crisis preferred fiscal consolidation and many of the EU member states have embarked on a series of austerity measures.  However, the Obama’s administration while acknowledging the dangers of excessive debt felt that it is necessary to continue with fiscal stimulus so as not to derail the economic recovery.  Mr Obama called the EU countries to avoid too aggressive measures to curb spending. To this, German Chancellor Angela Merkel answered that the EU needs a growth built on solid economic fundamentals rather than debt-based growth.

As the debate was more about the timing than the general belief that it is necessary to attain balance in public finances, the Toronto Declaration seemed to have a reassuring line for everyone: “There is a risk that synchronized fiscal adjustment across several major economies could adversely impact the recovery. There is also a risk that the failure to implement consolidation where necessary would undermine confidence and hamper growth.” The Declaration states expectations (not binding requirements, as stressed by the French President Nicolas Sarkozy) that countries would halve their deficits by 2013 and the ratio of government debt to GDP would be stabilised by 2016. “The Summit’s result reflects widespread convergence around Europe’s approach,” European Commission President José Manuel Barroso and President of the European Council Herman Van Rompuy said in a joint declaration.

Apart from this broad policy statement, there were no other major breakthroughs. Countries continue to disagree on how to proceed with financial regulation reform. The EU came to the summit with a proposal to create a global bank levy, but the idea received a frosty welcome at the summit. Although there was “a common position of all the European countries” and the European representatives were “determined to defend it in Toronto, the EU did not succeed in convincing the rest of the G20: the idea was supported by the US, but opponents, including Canada, Australia, Japan, China, Brazil and other emerging economies, managed to rebuff the proposal. The Declaration simply noted that there are various policy approaches to make private banks pay a “fair and substantial” contribution towards any government interventions: “Some countries are pursuing a financial levy. Other countries are pursuing different approaches.”

This now leaves the EU Member States with a difficult calculation: how much they can make their banks pay, so that not to see them shifting operations to more tax-friendly places. The European Commission will come out with a report on the issue in October, following the broad agreement reached at the 17 June summit of EU leaders that countries should enact “levies and taxes on financial institutions to ensure fair burden-sharing and to set incentives to contain systemic risk”. In the meantime, various EU Member States are already working on this. On 22 June, the British Chancellor of the Exchequer, George Osborne, unveiled plans for a bank levy in the United Kingdom, to be introduced from 1 January 2011 (the tax will charge 0.07% of a lender’s total liabilities, although a lower rate of 0.04% will apply in the first year). A similar tax has been already implemented in Sweden, whose “stability fee” charges banks 0.035% with the money dedicated to a fund for future bailouts. Germany is expected to propose legislation this summer, with France following in the autumn.

In fact, a majority of G20 countries considers that it is more important to address the question of bank capital and liquidity rules – the so called Basel III reforms, named after the Basel Committee on Banking Supervision, based in Switzerland. The idea is to raise the capital, in order to create financial buffers for banks to ensure that in future they can better endure economic shocks. The G20 leaders stressed: “The amount of capital will be significantly higher and the quality of capital will be significantly improved.” Yet, the implementation timeline was weakened, with the previous target of achieving the new standards by the end of 2012 being dropped and allowing different speeds for different countries. France, Germany and Japan feared that demand to build up such capital, if implemented too quickly, would stifle lending and harm a fragile economic recovery.

Altogether, the G20 meeting did not resolve the existing short-term differences; it rather gave the countries plenty of flexibility. Much of the technicalities will have to be decided by November this year, when the next G20 summit will take place in Seoul, South Korea.

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