Linda Zeilina: Good Morning Sony, welcome to the first in our new series of 'Conversations with Re-Define'. So, market confidence seems to have returned and there is certain optimism in the air and ECB president Draghi has said that there are signs of ‘positive contagion’. Would you say that the Eurocrisis is finally over?
Sony Kapoor: I think that the optimism has gone too far. The Eurozone real economy is continuing to contract and the situation in Italy and Spain, both of which are amongst the biggest economies in the Eurozone, is particularly dire. France is not doing well either; the Greek economy is now 20% smaller than it was at the start of the Eurocrisis. Nor are Ireland and Portugal in great shape. These are just the countries that we already knew were in trouble. If you cast your net a bit broader, Austria, the Netherlands, Finland, which are supposed to be the stronger economies, are also in trouble and Germany is not immune when all economies around it are shrinking.
This piece was first written and circulated on the 2nd of September and appeared as a comment piece in Le Monde on the 10th of September
The Eurocrisis is on a pause as markets and EU leaders alike wait with bated breath for ECB. President Draghi, who has promised the European Central Bank will not let the Euro fail, to reveal his hand. They are right to think what the ECB will say or do is very important, but it is hard not to feel that too much is being expected of the ECB.
Between the things the ECB cannot do and the things it will not do, its ability to deliver a sustainable ‘big bang’ has been severely curtailed. There are three main reasons to suspect that no matter what the ECB does this week or the next it will not be sufficient to stem the Eurocrisis. Those who have their hopes riding on the ECB are best advised to recognize that while larger scale ECB interventions are necessary, they are simply not sufficient to bring the Eurocrisis under control.
Following Mario Draghi’s remarks last week in London, wherein he promised that the ECB stood ready to do ‘whatever it takes’ to save the Euro, as long as it was ‘within its mandate’, the markets were flooded with a wave of optimism. This optimism took on frenzied proportions as the head of the Austrian central bank, one of 23 members of the ECB’s governing council, evidenced support for the idea of the ESM getting a banking license. Much of this optimism has vanished in the face of the reality that confronted markets at the ECB’s press conference today. That is not to say that there has been no progress, only that what has been announced is not a game-changer.
We were sceptical at that time and said so. It turns out we were justified in our scepticism. The ECB did not intend to, nor was capable at this point of delivering a 'bazooka'. It has outright rejected the idea of the ESM getting a banking licence, once again. It has however held out a promise to reactivate the defunct Securities Markets Program (SMP) albeit with some important modifications. This note discusses what this means and what impact this may have on the progression of the Eurocrisis.
Spiking skywards? Tackling rising yields in the Eurozone
The Eurocrisis is once again dominating the headlines. Renewed talk of a Greek exit, record yields for Spanish bonds and rising Italian borrowing costs have been splashed all over newspaper headlines. This week Spanish bond yields reached new record highs breaching the 7% level for maturities of two years and above. Italian yields too were trying new highs.
Then the president of the ECB spoke saying that the ECB would do "whatever it takes" to save the Euro. The markets reacted positively and yields fell. There is an expectation in the markets that policy makers may come up with some new measures to address the spiking yields soon. We are much more sceptical both of their immediate intentions to enact more measures and their ability to bring the yields down sustainably. One could hardly expect the president of the ECB to not say that he would do whatever it takes to save the Euro. This Policy Brief addresses two questions 1) why are spiking yields a problem? and 2) what are the near-term options for bringing these down.
The Spanish Donkey, a feared torture device from the middle ages, consisted of a wedge on which the victim was seated with weights tied to his or her legs so that with enough weight, the wedge could even slice though the victim’s entire body. Arguably, the Spanish economy now sits atop such a wedge weighed down by deep austerity measures and unprecedented unemployment on the one side and by large unknown losses in the banking system brought about by a real-estate bubble that has burst on the other.
What is worse is that these two aspects weighing the economy down reinforce each other in a manner that is clearly not understood that well by EU policy makers. The Spanish economy today is at a point where every bit of austerity, measured in percentage points of GDP, leads to a reduction in demand that is even larger. So a 1% cut in government spending is likely to lead to a fall in GDP that is larger than 1%. This is because the uncertainty over the future of Spain and the fact that tomorrow, at this point, looks worse than today mean that neither consumers nor businesses are spending so a reduction in government spending translates directly into lost demand in the economy. What’s worse is that the expectation of falling GDP that accompanies such austerity means that both consumers and firms will make further cutbacks to their consumption and investment plans.