After Spain, it’s Italy’s turn in the Eurocrisis spotlight. The immediate cause for this spotlight is a two notch downgrade of the Italian sovereign by Moody’s, a rating agency from A3 to Baa2, just two notches above the dreaded junk status. Despite the downgrade, Italy is not Spain and the fact that the downgrade had a rather limited impact on the pricing of Italian bonds issued in its immediate aftermath reflects some of its fundamental strengths.
Nevertheless, expect this to generate a barrage of strongly worded public criticisms from European leaders, but the truth is that they only have themselves to blame. The single biggest factor weighing on the Italian economy at present is the uncertainty about whether or not the Eurocrisis will be resolved. And it is this, rather than Italy’s own domestic situation (which is also complicated), that is the most serious problem.
The terms of Spain's bank bailout are being finalized and this draft memorandum is a near final verison that lists the timeline and details of how this bailout would be conducted. While the draft looks rather comprehensive on first glance and does have several positive elements, it is also afflicted by a number of glaring omissions.
The first of these is that the memorandum fails to understand or acknowledge the link between the macroeconomic policies being pursued by Spain, for example on cutting its fiscal deficit, and the stability of the financial sector. In fact, many of the new austerity measures adopted by Spain will undermine the objectives of its bank bailout program. It also fails on take note of the social and political realities. Crucially, it makes no reference whatsover to the direct injection of equity by the European crisis funds, now or in the future.
The last sentence of the European Council Communique from the June meeting simply states “We task the Eurogroup to implement these decisions by 9 July 2012.” This was always going to be a stretch and as expected the marathon 10 hour meeting of the 9th of July has failed to do any such thing as is clear from the Eurogroup communique.
As we discussed in detail in our report following the European Council, there were four important decisions taken that day. Some of these, such as the decision to set up a Eurozone-wide bank supervisor, the decision to allow Eurozone crisis funds to directly inject equity capital into troubled banks in member states got a lot of people excited. However, as we discuss in this commentary, the Eurogroup meeting provided a good reality check for those who may have got carried away after the better than expected (only because expectations were managed so low) results from the European Council meeting in June.
The short but important conclusions from the all night summit of Euro area leaders can be found here.
First the good news, four very important decisions were taken 1) A decision to eventually hand the European Central Bank direct supervision of Eurozone banks 2) A decision to allow, in principle, the European Crisis funds the EFSF/ESM to directly inject equity into troubled banks 3) A decision to waive seniority or preferred creditor status that Member States had claimed for the ESM, for Spain’s rescue 4) An agreement to activate crisis support for Spain and Italy through the EFSF/ESM buying bonds in order to bring borrowing spreads down.
At the eve of what is now being unofficially billed as the summit to save the Euro, things are not looking good at all.
To put it mildly, no one is expecting miracles from this summit. It would be enough if they can avoid this being a disaster.
The political space is now much smaller and the size of the economic problem now much bigger than at the last such comprehensive summit in March 2011. Despite this, the summit will devote far too much time on a highly ambitious political integration agenda, much of which is unachievable in the near future and devote far too little time to tackling the growing economic problems, where action is urgently needed now.