Fisher Investments Editorial Staff
Geopolitics, Developed Markets, Deficits

A European Spectacle

By, 01/31/2012

EU leaders held their first 2012 summit on Monday, and (as we’ve come to expect over the last few years) it was a spectacle of diplomatic jousting. The squabbling centered on two issues: Greek debt reduction and the nascent fiscal compact.

Tough talk on Greece

The Greek controversy started Friday, when word leaked of a German proposal to place Greece under the European Commission’s conservatorship (Chancellor Angela Merkel was initially credited, but she’s taken a softer public stance). EU officials are frustrated over Greece’s apparent lack of tangible austerity progress. The government has announced numerous spending cuts, tax hikes, labor reforms and privatization plans, but implementation is slow going, and as the economy continues contracting, deficit targets are slipping farther away. Compounding things, Greece must make a €14.4 billion bond repayment on March 20 and doesn’t seem to have the money. To get it, under October 2011 bailout terms, the government needs to finalize a debt restructuring deal with private-sector creditors and make credible progress on wage reductions, property tax hikes and social benefit cuts.

EU leaders are loath to lend more without some way of guaranteeing actual progress—hence Germany’s proposal: Appoint a special commissioner to dictate and implement Greek reforms. This set off a firestorm. Greek leaders said the proposal “ignores basic historical teaching” and is “the product of a sick imagination.” Some nations, including Sweden and the Netherlands, tentatively supported Merkel, but Austria’s chancellor denounced it. As did Jean-Claude Juncker, Luxembourg’s prime minister and the head of eurozone finance ministers, who deemed it “unacceptable.” And late Monday, French President Nicolas Sarkozy rejected it.

Given the backlash and the fact other peripheral nations likely don’t want to set a precedent of stripping national sovereignty, it’s highly unlikely the plan goes through. To us, this flare-up seems an exaggerated version of the politicking that’s accompanied all Greek bailout negotiations. Right or wrong, threatening to strip Greece’s budget sovereignty seems a way to get its government to enact tough (and domestically unpopular) reforms in a hurry. And perhaps Merkel thought looking tough would be a way to buy back just a bit of the political currency she’s spent on this process.

Greek PM Lucas Papademos appears to get the urgency, and he says the upcoming election’s leading candidates are on the same page—including poll-leader Antonis Samaras, who has long echoed the EU’s austerity demands. Plus, negotiations with private creditors for a 70% net haircut are reportedly nearing completion. Overall, it seems likely Greece does what’s necessary to get more funding without a conservator taking over—as it has every other time.

Signed, but not quite sealed and delivered

When last our European friends convened, they agreed in theory on a Franco-German fiscal compact aimed at toughening the Maastricht Treaty’s Stability and Growth Pact. The agreement, now drafted, includes more stringent “debt brakes,” like penalties (fines up to 0.1% of GDP) on countries whose debt exceeds 60% of GDP or whose structural deficit (ex-debt service costs and economic impact) exceeds 0.5% of GDP.

All participants signed the pact Monday afternoon. However, it’s far from a done deal. The legal status of the penalties for budget rule-breakers is in doubt. As written, the pact gives the European Court of Justice power to impose the fine—but it’s unclear how rule-breakers will end up before the court. Typically, the European Commission launches legal proceedings against treaty violators (see Hungary), but thanks to the UK’s veto, this isn’t an official EU treaty. That makes the Commission powerless to take legal action. It would thus fall to other nations to effectively sue the rule-breakers—not impossible, but a diplomatic nightmare. And if things made it that far, experts are divided over whether the court’s verdict would be binding under EU law.

It’s also far from certain all participating nations’ parliaments ratify the agreement. The Czech Republic already backed out after agreeing in December, and some of the 25 heads of state who ultimately signed the deal weren’t necessarily in love with it. Luxembourg’s foreign minister called it a “waste of time and energy,” and a Finnish minister deemed it “at best necessary and at worst harmful.” Poland’s PM refused to sign unless non-euro participants were granted a louder voice, and Sweden’s and Bulgaria’s parliaments have already rejected key provisions, including tax harmonization and ceding budget sovereignty to Brussels.

Thus, despite the 25 signatures Monday, it seems likely this agreement gets watered down before it’s ratified—if it ever is. And that, in our view, is quite all right. Any sweeping change officials agree on quickly in an attempt to “fix” things would likely prove a solution in search of a problem. For instance: If a country’s already heavily indebted or running a high deficit, why exacerbate that by imposing a fine?

The eurozone slow-go frustrates many, and that probably continues as officials continue grinding things out. But a measured, incremental approach—changing only what needs changing to make what progress needs to be made at any given time—seems the most sensible way to lower the risk of unintended consequences.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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