Protracted rescue could cost Europe, economists warn
Bail-out loans and liquidity injections will continue to be essential in propping up the eurozone this year but securing emerging market support may prove costly, economists and analysts argue.
Last month the European Central Bank (ECB) offered the first of two new long-term refinancing operations (LTROs), which will last for three years, to boost interbank lending.
More recently the International Monetary Fund (IMF) asked its members for an extra $600 billion (£382 billion) to increase its firepower, having estimated global fiscal emergencies will require bail-out loans of $1 trillion over the next two years.
Furthermore, plans to replace the European Financial Stability Facility (EFSF) – set up in 2010 as a temporary rescue fund for eurozone member states – with the European Stability Mechanism (ESM), a permanent programme, were recently brought forward to this year.
Although at last week’s World Economic Forum Christine Largarde, the IMF managing director, instead proposed the merger of the two funds.
Across Europe a lack of political co-ordination prevails and politicians remain reluctant to take tough decisions, dampening hopes of reform. (News analysis continues below)
Stuart Thomson, the chief economist at Ignis, says reticence among politicians will continue.
“We don’t think European politicians will take action and we think the ECB will continue to increase its balance sheet this year,” he says.
“There is plenty of money in Europe for it to help itself, but there is no political co-ordination.”
“European governments can’t commit taxpayers’ money where they do not have permission. It is going to be a long, hard slug for Europe and the financial markets this year.”
Although Thomson says it is unlikely the IMF will manage to attract even a third of the $600 billion it has requested, he is optimistic the fundraising and the ECB’s initiatives will limit the extreme tail risks and prevent the systemic problems in Europe leading to problems in the rest of the world.
However, he warns that with the growth forecast for the global economy below its production potential, there will be a rise in unemployment and therefore further political volatility and less co-ordination.
Dan Morris, a market strategist at JPMorgan Asset Management, agrees that pumping money into the eurozone will be used as a sticking plaster for the foreseeable future.
“The IMF’s intervention is a stop-gap and could be for a long time,” Morris says.
”The emerging markets have a case for asking why they should contribute when Europe is more than rich enough to help itself”
“But the ECB, which is providing liquidity to the banks while the governments get on with their reform packages, is providing more of a stop-gap. People are sceptical so it may take the rest of the year to see a slow increase in confidence.”
Morris is slightly more optimistic on the prospects of reform in the beleaguered countries, namely Greece.
“Reform in Greece is a bigger concern than its potential to default,” he says.
“Greece has been bad at implementing its policies; there was a big problem with the last tranche of money it received. But now politicians are trying to get re-elected there is a bigger trigger.”
Meanwhile, Germany’s focus on austerity and reluctance to top up the rescue funds is widely seen to be holding back the eurozone’s recovery.
At the World Economic Forum Angela Merkel, the German chancellor, made no mention of Germany contributing further to the fiscal stimulus, instead continuing to push the case for budget cutting in troubled economies.
While Germany is in discussion with other member states about creating a fiscal union, Thomson says: “Germany is not willing to pay the financial consequences of a money union.”
“The rest of Europe is not putting up enough money and Germany cannot afford to fund the periphery.”
Proposals by the European Commission to create eurobonds – vehicles that would collectivise debt across the eurozone – have also been shunned by Germany, on the grounds it would push up their cost of borrowing.
“The proposal to create eurobonds is still illegal under German constitution, and inconvenient truths such as this cannot be ignored,” Thomson says.
“There is a constitutional crisis at the heart of Europe. Germany is very strict about the transfer of power, so unless there is a referendum to change the rules, I don’t see that happening.”
“All the ECB can do is provide liquidity to buy time while the deleveraging continues.”
With Germany reluctant to bolster the IMF’s firepower, and America and Britain also refusing to contribute, the IMF is looking to the emerging markets to foot their share of the funding.
However, financial input from emerging markets will be bound to come at a price.
“The emerging markets have a case for asking why they should contribute when Europe is more than rich enough to help itself,” Morris says.
“With China there will be some kind of implicit understanding it will get something in return, which may make other countries less eager to contribute,” he warns.
Thomson predicts the emerging markets will request a greater say in how the IMF is run and demand to be top of the pecking order.
“They will want to be at the top of the capital structure, and they will get that,” Thomson says. “The debt of any country helped will then be subordinate to the IMF loan,” he adds.
Gabriel Stein, a director and economist at Lombard Street Research, agrees it is unlikely China and the other emerging economies will be prepared to contribute without a similar favour.
“This is likely to be rectifying their proportion of working share capital, which does not match the size of their economy,” Stein says.
“The western influence on the IMF will diminish, so there will be political consequences.”