As European Union leaders gathered in the Belgian capital once again this evening, the focus of their negotiations would be on what has widely been billed as the “final package” of policy measures needed to put out the region’s billowing fiscal fires once and for all.
But markets and investors alike are increasingly weary of the repeated “final solution” rhetoric. For them, it only amounts to crying wolf. At a July 21st summit, German Chancellor Angela Merkel had proclaimed that European leaders “have risen to the challenge”, while French President Nicolas Sarkozy hailed the meeting as a “historic turning point”.
Three months later, the continent’s fiscal bleed remains unstemmed, leading to an October 23 summit. There a final, final package was to have been revealed. And now three days later, the summitry continues: the 14th such meeting in 21 months.
Merkel, the star amongst the tale’s dramatis personae, will fly into here with her negotiating hand strengthened after having — earlier in the day — won a parliamentary vote in support of increasing the firepower of the EFSF (European Financial Stability Facility), the euro zone’s bailout fund. The need to secure German parliamentary support beforehand was one of the key reasons why last Sunday’s summit was unable to take any conclusive decisions
But even with the Chancellor winning support at the Bundestag, disagreements over the details of the main policy measures being considered remain, raising the prospect of a weak summit outcome, despite global calls for strong moves.
The main points of contention are threefold: the scope of the haircuts that investors must agree to on Greece sovereign debt, the role of the European Central Bank in addressing the crisis going forward and the best way to leverage the EFSF.
Greece, the recipient of 110-billion euro in bailout money, is counting on bond investors to accept “voluntary” losses as high as 60 per cent and on euro governments and the International Monetary Fund to lend at least 109 billion euros more to enable it to pay its bills.
But financial companies, represented by the Washington-based IIF say a 60 percent write off would be akin to a forced default and could trigger a raft of claims for insurance contracts, known as credit default swaps, to cover bond loses. Instead, they are proposing a more moderate 40 percent haircut —up from the 21 per cent already agreed to in July.
Merke, in her speech to the Bundestag this afternoon, called for the private sector to make a significantly larger contribution than previously agreed to reduce Greece’s debt burden. While she did not put a figure to it, the chancellor said the aim of the EU summit must be a solution that allows for Athens to cut its debt to 120 per cent of the GDP by 2020.
The amount of Greece’s bond writedowns will determine the amount of damage to European banks with exposure to that debt. EU leaders are expected to agree that the banks in the region will require just over 100 billion euros of extra capital to buffer them against the shock of the Greek haircut. Banks are thus likely to be asked to raise their core Tier 1 capital ratio to 9 per cent of their assets by mid- 2012.
The other vexed issue that will be discussed at the summit involves the leveraging of the EFSF. Germany has refused to consider the French proposal of turning the fund into a bank that could then have access to ECB funds. Instead the two main ideas that have been floated involve using the EFSF to guarantee a portion of new bond sales and creating a special purpose investment vehicle (SPIV) that would court outside money, including from the IMF and emerging economies, notably China. EFSF chief executive Klaus Regling will be leaving for Beijing tomorrow, giving rise to speculation that a deal with China to invest in the SPIV is about to be struck. Concrete numbers as to the expanded scope of the EFSF are not expected to be agreed to on Wednesday pending discussions with potential investors like the IMF and China.
Moreover, Germany will likely make its support of a more robust EFSF contingent on the ECB quitting its bond buying of PIIGS (Portugal, Ireland, Italy, Greece Spain) economies. The Frankfurt-based central bank has bought 169.5 billion euros in PIIGS bonds so far. The increasingly controversial policy contributed to decisions by both Germans on its council to quit this year. Berlin fears the ECB’s bond-buying compromises the bank’s independence and its ability to control inflation.
But many European officials feel that ECB involvement in the crisis resolution will remain crucial because mechanisms to scale up the EFSF won’t be ready immediately after the summit.
Underscoring the disagreements that continue to vex euro zone discussions, a critical meeting of EU finance ministers, which was to have been held on Wednesday, was late yesterday abruptly postponed to an unspecified date. The finance chiefs will now await further political direction before working out the technical nitty gritty that any solutions proffered at the summit will entail.
