Transcript | 8. lecture: Possible ways out of current situation, real solutions (Vladimír Vaňo) - University for modern Slovakia

The beginning of the end of euro-area or catalyst for changes and reforms?

• Chinese people regard the crisis to be the opportunity.
• Is a current debt crisis in euro-area going to be the beginning of its end and break-down or a catalyst for changes which strengthen the Eurozone for the future cyclically repeated recessions (and related deepening deficits)?
• Would it not be easier and cheaper to let the situation develop its own direction and not get down to mutual costly solutions to keep the credibility of the Eurozone and Euro? What is the cost of this scenario?
• Is EFSF (the European Financial Stability Facility) itself sufficient solution to the debt crisis in the Eurozone and is it not needed to try more?
• What is the role of EFS/ESM in solving the situation of the euro-area bond market and what are other parts of a complex solution to so-called debt crisis?

Why deepening the deficits?

• A starter for current tensed situation on euro-area bond market was the most serious global post-war recession.
• This recession caused cyclical deepening the deficits in almost all countries of euro-area and in the European Union. The average deficit of public finances within euro-area was in the crisis year deepened to more than 6% of GDP.
• A serious worsening of public finances management noticed not only member states  which did not manage their public finances before the recession very wisely, but also those which before recession reached surplus in their national budget (for example Spain, Ireland).

Why European version of IMF?

• In case of countries with high public debt, the cyclic deepening of public finances deficit worsened the risk perception of an eminent to that extend that because of extremely high interests required in the bond market, some of the Eurozone member state were forced to obtain bridge loans from the transnational creditors.
• Commonly available “safety net” for the countries in temporary problems with refunding of their public debt is the International monetary fund which for example in October  2008 saved neighbouring Hungary, and it helped Romania and Serbia by bridge loans. 
• When the first country from member states of the Eurozone ended up in a situation similar to the one of Hungary in 2008, there were voices not only from the ECB calling for the bridge loans at the expenses of the Eurozone members. The biggest contributor to IMF is the USA. The Eurozone uses, as its own currency euro – the only real competitor to American dollar, as a reserve currency number one.
• This way was compiled a bilateral bridge loan agreement to Greece, followed by the European Financial Stability Facility (EFSF) Agreement – as an European version of IMF. IMF contributes to the bilateral loan to Greece and to EFSF by a professional help and financially (approximately by one third).
• Similarly to IMF, also its European version, mediates financial assistance to the countries which have problems caused by the recession with refunding their public debt, it helps to obtain bridge loans whose drawing is conditioned by the strict and repeatedly evaluated healing measures which should help the country to come back to bond market as soon as possible.
• The example of Ireland, which announced that in 2012 it plans to come back to the bond market, shows how this time-tested model of IMF (as well in the case of EFSF) should work. This strictly limits the sovereignty of the countries accepting the financial assistance when deciding about their budgets.

Price for letting the situation to unrestrained development

• At first, we must emphasize that in the case of member state of the Eurozone, there is not and has never been a possibility to choose between the help from the other member states and letting the country in an unrestrained development to help itself.
• There were options to choose from: an option to get help from IMF (similarly as in the case of Hungary in October 2008), or an option to get help at the expenses of the Eurozone members themselves.
• A hypothetical (and concerning the existence of IMF also less likely) scenario when a member country of euro-area was left in difficulties to help itself, would lead to domino effect of other related and undesirable consequences:
  • A serious deepening of the recession in that country and even more painful economic consequences than are accompanied with the process of fulfilling healing requirements of international creditors.
  • In regard to national bonds of the Eurozone members, which are considered by foreign central banks to be the reserve assets, the scenario of an unrestrained development in one of the member state of euro-area would seriously harm the credibility of euro as a reserve currency. As a result, there would be (at best) weakening the demand for national bonds of member states of euro-area, or their sale from the portfolios of foreign central banks. In both cases the harm of credibility of euro as a world reserve currency number two would negatively influence all other Eurozone members in the form of increased interest costs. The total debt of the Eurozone members, which is concurrently refunded on bond market, exceeds 85% of GDP.
  • A shock, caused by such event between the investors (similarly as the events in the USA in September 2008), would seriously deepen turbulences on the financial market. Primary task of the financial market is the mediation of capital for a real economy, the companies which produce and provide services, but most importantly employ. As we could experience at the end of 2008, the turbulences on the financial market could through the limitation of capital availability negatively influence the real economy as well. It means that the turbulences can deepen its weakening including decrease of employment. And that is in the whole Eurozone.
  • The Eurozone is not only a project of 17 member states taking part in it. It is at the same time a flagship project of the whole European Union, however not all its members have accepted euro as their currency. Impeachment and endangering the credibility of the Eurozone could have geopolitical consequences to the process of European integration itself.
  • This scenario causes such immense domino chain of negative consequences that all the participants put a maximum effort into the prevention, including IMF and other big world economies (of the USA, Japan and China).

Why EFSF (the European Financial Stability Facility) and ESM (the European Stability Mechanism)? Who and how contributes into them?

• The European Financial Stability Facility (EFSF) was established as a European version of IMF and on financing of which participate the member countries of euro-area together with IMF. As the original agreement – the EFSF Agreement was made hastily; it was made for a definite time to 2013. After this period, the functions of EFSF should be taken over by the European Stability Mechanism (ESM).
• Shares on the authorized capital of EFSF/ESM are agreed (with some temporary exceptions – for example decreasing the share of Slovakia) using the same uniform method which was at the foundation and extension of the EU agreed by individual members in the case of “shares in ECB.”
• These shares are the basis for the claims for the distributions from income of ECB if they are paid out. Because the aim of EFSF/ESM is to mediate assets gained on the financial market to the “client countries” which are in difficulties. Provided common function of this process (borrowing the money on the market and mediation of these assets with some margin to the country which needs it), EFSF makes profit.
• Slovakia has contribution to the authorized capital of ECB of 0.69%. The members of euro-area make 70% of the capital of ECB; it means that the share of Slovakia, using this method (accepted when joining EU) is approximately 1 per cent.
• By deposits into EFSF are made warranties of individual member countries. As EFSF is a mutual project of the countries which not all have the highest rating, the rating agencies initiated increasing the deposit to EFSF of a cash contribution. For the member countries it has character of assets.
• Thanks to partial cash deposit, EFSF has the highest reachable rating (AAA) what enables it to borrow money on the bond market with the best available conditions.

Where do ESM, EFSF and IMF (euroval) take money for bridge loans?

• Every country when refunding its public debt uses national bonds with a definite maturity date as an instrument.
• There are two options when the bond matures: either to pay the bond off from the surplus of the national budget or to pay the principal by borrowing money by issuance of new national bonds with the defined maturity date.
• Exchanging mature national bond by issuing a new one, the existence of the public debt does not change; it only postpones mature date of a part of the public debt.
• A standard process of refunding mature bonds by issuing new bonds is not making “new debts”, it only postpones the maturity date of those which are mature.
• In connection to the level of rating and perceived risk as well, the private investors on the bond market require an additional risk surcharge for undertaking a credit risk. In case the perceived risk and related additional risk surcharge for the country is too high, the country can decide for the financial assistance from the transnational creditors: either from IMF or from EFSF when the country is a Eurozone member state.
• Any international bridge help has only a temporary character and likewise an “intensive care unit”, it serves only for creating the conditions for renewal and forming of the public finances and economics of that country (see Hungary 2008-2009).
• This is the reason why the international help from transnational creditors has strict and regularly evaluated conditions for renewal of the public finances, so that the debtor with the refunding of public debt could come back to the bond market on their own feet.
• From where does the transnational creditor, as EFSF is, take money which they moderate to their “clients” as the bridge loans? By issuing their own bonds on the bond market, i. e. loans from the same private investors (and foreign central banks) which the country with difficulties would borrow from, but this would be incomparably more expensive.
• EFSF is the mutual project which is due to its highest possible rating able to mediate the loans/credits for refunding the public debt to the countries in difficulties less costly.  
• The price for this mediation are strict and regularly evaluated conditions for healing of public finances of a country which understands that it is reliant on such help without which its economic development would be much more difficult.
• In the initial bond issuance of EFSF were among the investors also few Asian central banks (see graph in video).

Is ESM, EFSF and IMF (euroval) a miraculous solution? What are their functions?

• EFSF itself is only an instrument for enabling the refund of public debt of countries which are not able to do so at their own expense. It is not and never meant to be “a miraculous salvation”, only a part of a solution which includes required reforms of the public finances and structural reforms of the economy.
• EFSF fulfills three basic functions:
  •  For member states, it provides liquidity for the smooth refunding of their public debts if they are not able to do so at their own expense.
  • It makes the price for refunding for these countries lower, i. e. it lowers their interest costs.
  •  It provides a space for realization of necessary budgetary and structural reforms in a more stable environment; it means without tension and attacks from the financial market.
  • EFSF is only one part of the solution to the debt crisis of these countries.
  • Because EFSF helps to prevent the worst scenario in case of the countries which are not able to refund their debts at their own expense, it helps to prevent related turbulences on the financial market.
  • It contributes to the stabilization of the financial market (which however, at the same time, expects healing the budgets of the countries which are under the “glass bell of EFSF”, out of the reach of sharks hunting for the weakest members of the group).

Is during the turbulences in the Eurozone better to be out of it? Some experiences of the neighbours.

• A look at the development of the additional risk fees of the countries out of the Eurozone (in video) clearly shows that it is not possible in the world of globalized capital market to close hermetically the turbulences at the borders of euro-area.
• The rise of aversion of investors against the risk which causes the tension on the bond market of the Eurozone contributes to the increase of the additional risk fees for non-members of the Eurozone.
• The neighbouring countries of the middle Europe are harmed by the rising tension in euro-area (on the financial market as well as in the real economy), they are also affected by rapid weakening of the exchange rates similarly as it was at the turn of 2008-2009.
• From the beginning of July to the middle of November, Hungarian forint was weakened about 16%, Polish zloty about 11%, Czech crown about 8%. At the September intervention against zloty weakening, the National bank of Poland warned that a rapid weakening in such a short time threatens the stability of the price level; i. e. through more expensive imports, consumer prices rise fastens. The neighbours not using euro experienced this in 2009 (graph in video to the first lecture).
• The countries of the region out of Eurozone feel the turbulences not only through rising the price for refunding of their public debt but also in the exchange turbulences for which (through more expensive imports in a form of faster inflation) pay all the consumers.

What is the reason for stabilizing the financial markets? Fresh experiences from interconnection of the financial markets and the real economy.

• Why is it necessary to put any effort to prevent shocking situations which could increase turbulences on the financial markets?
• The financial market does not follow the line anyway. The difference is in the range of short-term volatility and its causes and also consequences to the process of mediating the capital to companies in the real economy.
• The primary task of the financial market is to function as a gate for mediating the capital for financing of companies from the real economy which produce goods and provide services but mostly which create free working positions.
• The exceptional turbulences on the financial markets impede the accessibility of the capital for the companies from the real economy.
• The best example of this experience is from the USA (in autumn 2008): the recession which had started in December 2007 meant for the American economy a monthly loss of working positions of approximately about 200,000 to August 2008. After the turbulences in September 2008, a monthly loss of working positions deepened about four times more (graph in video).
• Also this fresh experience reminds us that exceptional turbulences can negatively influence the labour market in, at first sight, unrelated sectors of the real economy. This explains the interest of participating countries to prevent such scenarios.

Does the calming of 2012 come from overseas as it was in 2008?

• The fact, that turbulences on the bond market of the Eurozone have impact this year also in the real economy on our continent, shows the seriousness of economic decline in comparison to overseas.
• We have spoken about the fact that in 2008 the recession came to the Eurozone through the lifeline of the foreign trade from the USA where the recession had started at the end of 2007.
• In 2011 we witnessed the calming of the activity on both sides of the Atlantic, in autumn however the indicators of activity in the sector of services and industry in the USA still persisted on the level of moderate rise, but still the rise. Contrariwise, in the Eurozone the leading indicators of activity in the industry and services warn against the threat of approaching economic weakening (graphs in video).
• The turbulences on the bond market of the Eurozone, through weakening the accessibility of capital for the real economy, contribute to the weakening of the economic activity in the real economy.
• This is also the reason why all the participants should prevent these turbulences or try to minimize their duration and range.

Why is it important to preserve the credibility of euro as a reserve currency?

• According to IMF, the national bonds of the Eurozone members contribute more than by one third to the foreign exchange reserves of the world central banks.
• Euro, which inherited this status from West German mark, became this way a real competitor to American dollar and the world reserve currency number two.
• The status of the reserve currency comes with a massive demand of foreign central banks for issuance of the national bonds of euro-area members.
• Thanks to this, the member countries of the Eurozone are able to refund their public debts cheaper than without this massive demand.
• The foreign central banks expect that the unity of the euro-area and its credibility (a part of which is credibility of each member) is comparable to the USA.
• Harm to this credibility and weakening the demand of the foreign central banks would feel all the members of the Eurozone in different range through increasing interests for refunding the public debt.
• In this case, a position of dollar would be stronger – as a position of dominant world reserve currency.
• The price for defending credibility of the Eurozone, besides other facts – therefore needs to be compared to potential costs in case of its harm.

Liberalization of the monetary policy without the trust of the private sector towards the renewal of the growth is not enough

• As we have seen in the case of Japan, after the weakening of the economic growth and breaking the trust of the private sector – companies and households – the liberalization of the monetary policy is not by itself a guaranteed solution to the renewal of the economic growth (graph in video).
• Only the economic growth and related increase of budget income is a sustainable way how to reduce the debt crisis.
• As we have shown, the instruments of the monetary policy can help to prevent the worst scenario (descending to the liquidity trap where the deflation is accompanied with stagnation) to happen but they themselves do not guarantee the renewalvitalization of the economic growth.

Budgetary stimuli as a way out of the economic stagnation

• As well on the case of Japan we have shown the fact that without trust and investments of the private sector, the attempts for renewal of the economic growth through budgetary stimuli (graph in video) are helpless.
• These are even less effective in the case of small and open economies as e.g. Slovakia (graph in video).

How to reduce relative amount of debt: practical experiences

• How is it possible to reduce the burden of the public debt without going bankrupt? There are two examples from the practice:
  •  After the World War II., the USA was able to lower their public debt in proportion to GDP thanks to the fact that the pace of the economic growth was higher than annual deficits in the public debt.
  • “Growing out of the debt” is not only a theory which confirms also an example from Slovakia. Thanks to the economic reforms in the last decade, it was able to start strong economic growth which exceeded annual deficits and influenced reduction of the relative expression of the public debt to less than 28% of GDP at the end of 2008.
  • The renewal of the economic growth is therefore an inevitable part and requirement of an effective solution to the debt crisis.

Prevention for the future: Quantitative change of relations within the Eurozone

• The experience from the first decade of the unique combination of one monetary policy and 17 independent budgetary policies in the last years proved that the future of euro-area requires a qualitative change of relations among its members.
• Inevitably closer budgetary integration does not mean foundation of a budgetary federation as it is known in the USA.
• For following the rules of healthy economy of public finances are needed effective but particularly timely sanction mechanisms. Those which are included in the Stability and Growth Pact treat members of the Eurozone very gently as the sovereign independent countries. In the name of better functioning of the club, the member may have to voluntarily give up part of this sovereignty.
• Thinking of closer fiscal integration take two main directions:
  • The foundation of the federal ministry of finances which would have its own competences but also its own sources (for example from distribution of part of indirect taxes or from issuance of “federal eurobonds”).
  •  Establishment of the international authority which would have competence regularly and timely sanctioning member states if they do not fulfill agreed criteria of conscious budgetary management of the economy.

What is the possible solution to the current situation: Reforms

• EFSF/ESM is not and has never meant to be the solution itself to the debt crisis in the Eurozone.
• The stabilization of the situation of the financial market is only a basic requirement and arranging the conditions for real and much more difficult parts of the solution:
  • The reforms of public finances, i. e. restoration of the balance between tax burden and the amount of expenses of the public budget. This could be done through cuts in expenses and accessibility of the public services, by increasing incomes and tax burden, or by combination of these measures.
  • The structural reforms which would help to start the growth pulled by the private sector through strengthening the competitiveness of business and investment environment.
  • Slovakia has its own experience with the effectiveness of this scenario from 1998-2002. The reforms from that period helped to start the growth thanks to which we were able to reduce the deficit of public finances from the critical levels. By the strong economic growth we were able to decrease also the amount of public debt in proportion to GDP under the level of 28% of GDP at the end of 2008.

Conclusion: The stabilization of the situation on the financial market using some effective and action-taking „European IMF” is only a basic requirement and arrangement of conditions for finding the permanent solution to the causes of the debt crisis: sustainable solutions are reforms of public finances and structural reforms for strengthening the competitiveness and reaching the best business and investment environment.

1.      EFSF/ESM is an inevitable instrument for stabilization of a situation on the financial market and for prevention from the serious turbulences which could affect the deepening of the recession and increase related loss of working positions through more difficult accessibility of the capital. 

2.      EFSF should help the countries with liquidity for refunding mature national bonds in better conditions so they have time and space for renewal of their public finances and structural reforms in economy without tension from the side of sharks from the financial market.

3.      The stabilization of the financial market through effective and action-taking “European IMF” is only a basic requirement and arrangement of conditions for finding the permanent solution to the causes of the debt crisis: sustainable solutions are reforms of public finances and structural reforms for strengthening the competitiveness and reaching the best business and investment environment.