Abstract
In this study, the risks related to the euro area sovereign debt crisis are analyzed. Methods used to implement the European Financial Stability Facility (EFSF) are overviewed, and the European Stability Mechanism (ESM), the European Systemic Risk Board (ESRB), and the European Supervisory Authority (ESA) are the important framework for financial reforms and macroprudential policies. In this paper, the improvement over the fiscal and structural governance stability and growth pact (SGP) and excessive deficit procedure (SDP) is discussed. Finally, the findings of spillover analysis are outlined.
In my capacity as President of EURIMF, I submit this Buff statement on the Article IV consultation with the euro area. It reflects the common view of the Member States of the euro area and the European Union in their respective fields of competence.
The authorities of the euro-area Member States are grateful for open and fruitful consultations with staff and for their constructive policy advice. The authorities welcome the staff’s Spillover Report and broadly concur with its findings. The authorities also stress their commitment to free trade and the conclusion of the Doha round.
The authorities emphasise that the efforts to implement a comprehensive response to the ongoing debt crisis have been forcefully stepped up over the recent months. These new efforts include reinforced commitments to fiscal consolidation and structural reform, the macroeconomic adjustment programmes in several countries, strengthening financial mechanisms for countries in distress, rigorous stress tests of the banking and insurance sectors and improvements in economic and fiscal governance. In spite of these bold efforts market volatility remains high. In this context, the authorities reiterate their resolve to take all the necessary actions to preserve the integrity and stability of the euro area.
Short-term economic outlook
The economic recovery in the euro area continues to make headway, even though at a moderate pace. While the external environment continues to support exports, the recovery is broadening out, with domestic demand contributing increasingly to growth. However, there are considerable differences in the pace of recovery across the euro area Member States. Labour markets, which on average showed remarkable resilience during the crisis, stabilised in the course of 2010 and are set to improve gradually, but dispersion in unemployment rates remain high. The authorities share staff’s view on the outlook. Economic growth in the euro area is expected to continue along a trajectory of around 2%. While investments contributed significantly to growth in the beginning of 2011, private consumption is expected to pick up modestly this year and its gradual recovery will be underpinned by slowly improving labour-market conditions, moderate income growth, and lower saving rates. Despite the positive prospects for economic growth in the euro area as a whole, uncertainty remains high and downside risks to the outlook are present.
Monetary policy and the outlook for price stability
The ECB early July decided to increase its key interest rates by 25 basis points, after having raised them by 25 basis points in April, in the light of upside risks to price stability. Inflation in the euro area is currently at 2.7% (June Eurostat flash estimate and May realisation), mainly reflecting higher energy and commodity prices. Looking ahead, inflation rates are likely to stay above 2% over the coming months. Risks to the medium-term outlook for price developments remain on the upside, in particular related to risks of higher than assumed increases in energy prices. The underlying pace of monetary expansion is continuing to gradually recover, while monetary liquidity remains ample with the potential to accommodate price pressures in the euro area. Recent price developments should not give rise to broad-based inflationary pressures over the medium term, thus there is a need to keep inflation expectations firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Upside risks to price stability will continue to be very closely monitored.
As regards the non-standard measures, the ECB in June decided to continue its refinancing operations as fixed rate tender procedures with full allotment in the third quarter of 2011. It furthermore suspended the application of the minimum credit rating threshold in the collateral eligibility requirements for bonds issued or guaranteed by the Portuguese government, as it had done before with Greek and Irish sovereign bonds. The provision of liquidity and the allotment modes for refinancing operations will be adjusted when appropriate, taking into account the fact that all the non-standard measures taken during the period of acute financial market tensions are, by construction, temporary in nature.
Fiscal policy
The authorities share staff assessment of the fiscal situation, in particular on the consolidation needs and the plans put forward by Member States to this end. Fiscal consolidation is a priority for the euro area as a whole, albeit with different degrees of urgency across the countries. Fiscal plans in the Stability Programmes broadly reflect this priority: they show considerable reduction in the general government deficit, with the euro area improving its fiscal positions every year, to reach an average deficit of 1.3% of GDP in 2014. Overall, the time profile of the consolidation plans is front-loaded and based mainly on expenditure reductions. Such a consolidation strategy will lead to halting and eventually reversing the increase in government debt as from 2012. The authorities agree that this hinges upon the rigorous and full implementation of the budgetary plans. Moreover, fiscal windfalls from higher than expected growth should be used for faster deficit reduction. Therefore, in the country-specific recommendation finalising the first European Semester, adopted by the Council last week, the Council called on Member States to take and implement all the measures planned and needed to ensure the achievement of their national fiscal targets and to comply with the recommendations under the excessive deficit procedure. This is essential to ensure trust by the public and markets in the sustainability of euro area public finances.
Financial stability mechanisms
Euro area Member States have significantly strengthened the stability mechanisms for countries in distress. It has been decided that the effective lending capacity of the temporary European Financial Stability Facility will be brought to € 440 bn, and a permanent European Stability Mechanism (ESM) has been agreed. The treaty which establishes the ESM was signed by euro are Member States on 11 July, and the ESM will be effective as from July 2013.
The main features of the ESM, including the conditions for granting assistance, were agreed and announced already in March 2011. If indispensable to safeguard the financial stability of the euro area as a whole, the ESM may provide financial assistance to an ESM Member, subject to strict economic policy conditionality under a macro-economic adjustment programme, commensurate with the severity of the economic and financial imbalances experienced by that ESM Member. The ESM will have an effective lending capacity of € 500 bn. The Board of Governors may decide, as an exception, to arrange for the purchase of bonds of an ESM Member on the primary market, with the objective of maximising the cost efficiency of the financial assistance.
The ESM will enjoy preferred creditor status vis a vis all official and private creditors, other than the IMF, to which it will be junior. However, this seniority over creditors other than the IMF will not apply to loans made by the ESM in support of programs that had already received financial support from European countries as of the date of the signature of the ESM treaty. An adequate and proportionate form of private-sector involvement will be sought on a case by case basis where financial assistance is received by an ESM Member, in line with IMF practice. The nature and the extent of this involvement will depend on the outcome of a debt sustainability analysis and will take due account of the risk of contagion to other Member States and third countries. If it is concluded that a macro-economic adjustment programme can realistically restore public debt to a sustainable path, the beneficiary country will take initiatives aimed at encouraging the main private investors to maintain their exposure. If it is concluded that a macro-economic adjustment programme cannot realistically restore the public debt to a sustainable path, the beneficiary ESM Member shall be required to engage in active negotiations in good faith with its non official creditors to secure their direct involvement in restoring debt sustainability. In the latter case, the granting of financial assistance will be contingent on the ESM Member having a credible plan for restoring debt sustainability and demonstrating sufficient commitment to ensure adequate and proportionate private-sector involvement. Progress in the implementation of the plan will be monitored under the programme and will be taken into account in the decisions on disbursements.
Collective Action Clauses (CACs) will be included in the terms and conditions of all new euro-area government securities with maturity above one year from July 2013, in such a way as to preserve market liquidity and in a standardised manner which ensures that their legal impact is identical. The detailed legal arrangements for including CACs in euro area government securities will be finalised by the end of 2011.
Financial sector
The authorities are in the midst of an ambitious and intensive programme of regulatory reform for the financial services sector, which includes better supervision and regulation for financial services, greater consumer and investor protection, and the development of appropriate mechanisms for crisis management. At the same time, fostering and deepening the single market for financial services remains a central policy objective.
The establishment on January 1, 2011 of the new supervisory framework marked a major step in the implementation of the reform agenda. The authorities welcome the European Financial Stability Framework Exercise and its findings. The authorities think that the track record of the new institutions is still too short to draw firm conclusions on their effective functioning, but first experience has been positive.
Against the backdrop of continuing funding pressure on banks, the authorities continue to press ahead with financial sector repair. The new round of EU-wide stress tests of the banking sector will be made available shortly. The test is more rigorous, based on more consistent application of the methodology and enhanced disclosure. Moreover, to strengthen market confidence, the authorities are currently putting in place in a coordinated manner credible backstops, compliant with EU state aid rules, to deal with any bank whose core tier 1 capital ratio fell below the threshold (5%) under the adverse scenario and requires public support. Meanwhile, the second European stress test exercise in the insurance sector has shown that European insurers remain robust.
The comprehensive regulatory reform agenda for the financial sector stretches over all financial market segments to reinforce the bed-rock foundations of the whole financial system. The main elements include: the implementation of the Basel III framework through the fourth revision of the Capital Requirements Directive and a Regulation implementing the single rule book, the revision of the Markets in Financial Instruments Directive, the Market Abuse Directive and the Transparency Directive, the proposed European Market Infrastructure Regulation and the Regulation on Short Selling and certain aspects of Credit Default Swaps, the legislative proposal on Central Securities Depositories (CSDs) and on harmonisation of certain aspects of securities settlement, the Regulation on credit rating agencies, Solvency II regulation for the insurance sector and the upcoming Commission proposals on an EU framework for crisis management in the financial sector.
At the same time, the authorities would like to stress the need for global coordination on financial regulation and supervision in order to maintain the level playing field and to avoid regulatory arbitrage.
Economic governance
In the aftermath to the global financial and economic crisis the authorities have embarked on a deep and comprehensive reform of economic governance in the EU and in particular the euro area. Once adopted, the new governance structure, together with the new supervisory institutions and the financial stability mechanisms referred to above, will equip the euro area with a more robust institutional framework, which will reduce the likelihood of economic and financial crisis in the future.
The authorities expect that agreement with the European Parliament on the legislative governance package will be reached shortly. The draft legislation aims at significantly strengthening fiscal surveillance by the operationalisation of the debt criterion in the excessive deficit procedure via a numerical benchmark and by introducing an expenditure growth benchmark, alongside the change in the structural balance, to assess progress towards the medium-term budgetary objective in the preventive arm of the Stability and Growth Pact (SGP). A new directive on national budgetary frameworks will reinforce reform efforts in this field and will improve the quality of the budgetary processes. In addition to fiscal surveillance, the establishment of a new excessive imbalances procedure (EIP) to correct excessive macroeconomic imbalances, accompanied by an enforcement regime, will strengthen the coordination of economic policies,, as advised by staff, and will work towards preventing macroeconomic excesses in the future. The decision making process under the new EIP incorporates a large degree of automaticity through the use of reverse qualified majority voting by the Council. Moreover, the EIP process takes into account the specific nature of macroeconomic imbalances, which are less under the control of the authorities and which may require more room for a case-by-case assessment.
Economic surveillance in the euro area and the EU as a whole has already benefited from the introduction of the so called European Semester, which aims at providing integrated and ex ante economic policy guidance to the Member States, in time to be taken into account in the formulation of national budgets for the following year. The first set of integrated country-specific recommendations was adopted by the Council in July, on a recommendation from the Commission. Marking a clear break with the past, the recommendations integrate fiscal and structural policy guidance and feature a much higher level of granularity and specificity than before in terms of recommended policy action. Moreover, the reform process has received an additional political impetus in the form of the Euro Plus Pact. With the Pact, the participating Member States committed at the highest political level to further strengthen the economic pillar of EMU and achieve a new quality of economic policy coordination, implementing a number of concrete policy actions which are key for improving competitiveness and avoiding harmful imbalances, thereby leading to a higher degree of convergence and preserving our social models.
Structural reforms
The authorities emphasise that the Single Market has been and continues to be the cornerstone of economic integration in the euro area and in the whole EU, and with the single currency the euro area forms the most economically integrated part of the world economy. Nevertheless, the authorities agree that there is still more potential to be exploited.
The Commission has presented a Single Market Act with a view to taking the Single Market to a new stage by tapping the full potential of the services sector, encouraging the uptake of a digital economy, facilitating cross-border transactions, improving access to finance, especially for SMEs and fast-growing innovative companies, increasing workers’ mobility by modernising the system for recognising professional qualifications, modernising standard setting and intellectual property regimes, and creating cost-effective access to energy. In services, a special emphasis is put on the need to remove non-tariff barriers to trade and to the harmonisation of product regulations and technical standards. The major recent liberalisation effort in the services sectors is the implementation of the Services Directive. Although it is too soon for its full effects to have materialised, it is expected to have a major impact on trade and FDI flows and has already created a momentum for services liberalisation. In network industries, progress has been made in opening markets and ensuing increased competition and further liberalisation is ongoing. The liberalisation in telecoms has led to a fall in the market share of the incumbent and to a reduction in prices. In the electricity and gas sectors, the implementation of the Third energy package will further enhance competition and integration.