Tighter dancing for all, EU tells its members

While Portugal passed Wednesday’s market test, EC issues framework to end states’ independence on budget making

As Portugal successfully held its first bond auction of the year, buying temporary relief from concerns that it was imminently in need of a bailout, a new era of more tightly coordinated economic governance between European Union member-states was formally launched today.

The highlights of an annual growth report that sets out the priorities EU national governments should take into account while devising their economic and budgetary policies for the coming years were announced by European Commission president Jose Manuel Barroso, marking the beginning of a new ‘European Semester’.

If agreed to by members at a summit in March, the move would constitute a major reversal of the practice where states draw up their budgets independently and only then tell the EC what was in these.

Structures
Barroso told journalists the report’s main recommendations focused on promoting fiscal consolidation and reform of the labour markets. Measures to promote confidence in the banking sector were stressed, with the need to create greater flexibility in labour markets to redress unemployment. Youth unemployment for the EU as a whole is 20 percent and in some countries like Spain, 40 per cent.

The need for a ‘European Semester’ and greater role at a European level to promote economic coordination across the 27 members was highlighted last year. The fiscal drama that unfolded, first in Greece and then Ireland, not only wreaked havoc in international currency and stock markets but revealed the political dimensions to this economic crisis. The EU’s credibility was proven to be sharply circumscribed by the irrationality at the heart of its workings.

The euro zone, for example, is a group of 16 member-states who share a currency but without any fiscal coordination. As a result, although the European Central Bank sets interest rates for the zone, it does so in a vacuum, with constituent governments retaining control over fiscal and economic policy. A major reason why, despite the creation last year of first a temporary and later a permanent crisis resolution mechanism for euro zone countries in trouble, markets remain jittery about the region is that such measures leave the fundamental contradictions at the heart of the problem unaddressed.

It is these underlying issues that the new European Semester hopes to take aim at, by increasing the ability of national governments to supervise each other’s budgets before they are passed by parliaments, a big step toward joint administration of fiscal policy. While they would not have the power to force a nation to rework its budget, they would be able to exert pressure to make the budget’s assumptions about economic growth, inflation and interest rates as realistic as possible.

Present issues
But even as the EC stressed the importance of long-term structural reform, the necessity for shorter term fire-fighting aimed at stemming sovereign debt contagion to Portugal and Spain remains in the spotlight.

The EU’s top economic official, Olli Rehn, called for the euro zone’s existing rescue fund, the European Stability Mechanism, to be reinforced in its effective lending capacity to calm debt markets. Separately, Reuters also reported it had seen an internal EC report recommending a one-off tax on banks to raise ¤50 billion to fund a future European Stability Mechanism.

Rehn refused to comment directly on Portugal’s successful debt sale but reiterated he was confident the reforms being undertaken by Lisbon were the right ones. Portugal was able to borrow ¤1.25 billion today and ended up paying a far lower rate for its longer-term debt than previously. The yield on bonds dropped to 6.716 per cent from 6.806 per cent the last time Lisbon tapped investors, in November

However, analysts warn that Portugal is far from out of the woods yet and that chances it will require a bailout remain high. Given the harsh measures Lisbon has implemented to whip its public finances into shape, the country may well slip back into recession. Moreover, its borrowing costs remain high.