The Eurocrisis never went away, nor did we!

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Many of you have noticed that Re-Define has been apparently missing in action having not sent out comments, given interviews or published papers or Op-Ed’s on the Eurocrisis or Financial Reform since the beginning of March. This was deliberate. It’s not that we have stopped working on these issues, far from it. It’s that we decided it would be healthy for us, given our sharp, but constructively critical tone, to stay away from the headlines for a bit.

Given the premature complacence that was creeping into policymaking circles, we got heat for continuing to insist the problems were far from over. For example, we were criticized in some quarters for being too negative at the last European Council in March when we said “This European summit reeked of missed opportunities, premature celebration and undeserved backslapping. This may come back to haunt our leaders sooner than they think.” (2nd Mar)

Now, the Eurocrisis, which we had always insisted had never gone away, is officially back. Spain, which we had repeatedly warned (in the face of much policymaking criticisms) faced challenges at least on some aspects that were greater than those faced even by Greece, is now at the centre of the on-going maelstrom. “Excessively sharp austerity measures in Spain may be worse than ineffective.The combined negative impact of a lower GDP, worse tax revenues and falling asset prices on indebtedness may exceed the targeted reduction in deficits.” (9th Jan) Our predictions of a Eurozone recession made in October have unfortunately turned out to be right as did our insistence that the problems in the European Banking System were essentially unresolved and the system remained on life support.

“Consumer demand is shrinking as public spending and wages are cut. With low confidence that is not conducive to stimulating private investment and a possibility of only marginally higher exports in the short-term this will arithmetically shrink the GDP worsening the Debt/GDP ratio even without the impacts of lower tax revenues and a higher demand for social insurance being accounted for.”(23rd Feb)

We had been very critical of the efforts put into the fiscal compact, and rightly so having said “Never have so many, spend so much time on something that so few wanted in the first place and which is largely irrelevant to tackling the crisis.” “The pointless squandering of scarce political and social capital on this compact is likely to continue for some time to come as EU leaders struggle to ratify this through parliaments and referendums at home.”(2nd March)

We have warned repeatedly about how the combination of sharp austerity, fragile banking system, hardening politics, shrinking economies and rising unemployment would threaten the social fabric, which is now clearly fraying in many of the crisis countries. Our fear, first expressed in Jan 2011 that if we kept pursuing the wrong strategy the size of the economic problem may exceed the political space available to tackle it, still keeps us awake at night especially when we think that this crossover may already have happened. We hope it hasn’t.

“The actions of EU policy makers, the difficult and controversial decisions on bailouts, conditionality and austerity which have been poorly communicated are all leaving a scar on the European psyche which could take years to remove.” “The growing size of the economic problem, the difficulty of necessary adjustments and the polarization of politics and public opinion all diminish the likelihood of a benign transition. The political space and permissive consensus necessary to tackle the problem are shrinking.” “Euro area austerity measures are only just starting to bite, the fabric of society has reached near breaking point in some countries and political capital and citizen patience are fast running out.” (Feb 23rd)

We were also right in our insistence that the European Central Bank’s Long Term Refinancing Operation would provide only temporary relief, do little to tackle the fundamental problems and may simply store up problems for the future. The ECB, we have long maintained needs to target sovereign yields directly, a self-imposed red line it has refused to cross so far.

“The ECB, having done the heavy lifting in recent months, is still refusing to cross the red line of direct sovereign support and must be considering an end to unlimited support for EU banks.” “However, the prospects of a sustainable exit of EU banks from life support as fraught as ever.” “Euro area banks continue to trade at a mere 40% of their book value, a symptom of the scale of their troubles.” “As the recession starts biting, the quality of the asset portfolios of these banks will deteriorate and they will face an uphill struggle and the dance of death between weak sovereigns and weak banks will resume.”(23rd Feb)

We have repeatedly said “Unless all doubts about the solvency of Italy and Spain are put to rest first, no amount of support would restore confidence in the European banking system.” (9th Jan) and we are right. We believe that the ECB can be the only effective firewall and will eventually have to target a maximum sovereign yield in Italy and Spain which it legitimately can in order to restore a proper transmission mechanism for monetary policy in the EU. As we have said, “no one in the real economy in Spain & Italy (or other crisis countries) can borrow anywhere close to the ECB policy rate”.

You may also remember that in a series of video interviews with Bloomberg TV between Jan and March 2012 we have been increasingly critical of the focus on increasing the size of EU firewalls as a best largely irrelevant distraction and at worst potentially dangerous. Instead we have been promoting the use of unused EFSF guarantees, and capital injections, towards increasing the capacity of the European Investment Bank. This and many of the other policies that Re-Define has been promoting under the rubric of a growth compact that we have been pushing policy makers to adopt since October, are slowly staring to gain traction.

The success of the Greek deal, that we had helped define some of the design and parameters for in work done at the beginning of 2011 was also encouraging but apart from that there are as yet few signs that the situation in the EU would improve soon. We had asked “How long before EU leaders finally manage to link the mystery of ballooning deficits in Spain, the Netherlands and elsewhere back to accelerated austerity driven collapse of tax revenues and growth?” (23rd Feb) Clearly, we are still waiting.

As you know, most of our time is spent working with EU, international and national policy makers advising them on how to tackle the Eurocrisis, improve financial regulation and put sound economic governance reforms into place. We have used the period away from the headlines to redouble our efforts on this front and have seen increasing successes in influencing policies in these areas as well as on environmental & development finance, the other areas we work on. You will be seeing more published stuff from us on all of these.

We have also just launched a new website, which we hope you will like better but it will be a week or so before it is fully functional. We will be using Twitter and Facebook much more frequently to put out comments and analysis so it may be best to follow us on these. You can also subscribe to our regular newsletters on the home page of the website. We remain at your disposal. 

On Behalf of the Re-Define Team 

Sony Kapoor 

Managing Director