In early 2010, fears of a sovereign debt crisis developed in Europe concerning few countries including Spain, Greece and Portugal. As a result, on 2 May 2010, the Eurozone and the IMF agreed to a loan of €110 billion to Greece. A week later, Europe’s finance ministers approved a package (totalling almost a trillion US dollars) to ensure financial stability all over Europe, by way of a new creation: the European Financial Stability Facility.
At a recent talk at the Singapore Institute of International Affairs (SIIA), Mr. Moritz Schneemann, financial affairs counsellor of the German Embassy in Singapore and representative of the Deutsche Bundesbank (German central bank) for Southeast Asia, discussed the European debt crisis in terms of fiscal stability in the EU and the long term impact of the crisis on the global economy.
Mr. Moritz highlighted three issues while explaining the current European debt crisis. First, the rationale behind sound fiscal policy, in particular in a monetary union. Second, the implications of the May res-cue package, and third, the future challenges of the European Monetary Union (EMU).
Mr. Moritz remarked that European Central Bank’s independence was a precondition for a stability-oriented monetary policy. However, he stated, independent monetary policy alone could not sufficiently ensure price stability in the long run. In other words: Central bank independence is a necessary, but not a sufficient precondition for maintaining the intrinsic value of money. As a general principle, a stability-oriented monetary policy must be accompanied by a stability-oriented fiscal policy. The need for sound fiscal policies is especially evident in a monetary union in order to avoid negative spill-over effects – primarily in the form of rising borrowing costs – from one member state’s budget to the rest of the union.
Mr. Moritz also stated that the financial assistance granted in May to Greece by finance ministers of the EU was based on various conditionalities. On 10th May, the finance ministers announced two packages. The first package granted Greece Euro 110 billion [80 billion from euro area member states - of which up to 30 billion in the first year - and 30 billion from IMF]. As a second package, finance ministers adopted a set of additional stabilisation measures, named European Stabilisation Mechanism. As one element of this stabilisation mechanism, Mr Moritz reported, euro area member states would set up a special purpose vehicle, due to expire after three years, which can grant loans to euro area member states. The necessary resources of this European Financial Stability Facility (EFSF) – up to a volume of 440bn € – would be raised in the capital market by selling bonds which are guaranteed by the other euro area countries on a pro rata basis. With regard to the European Stabilisation Mechanism, it was important that any drawdown of funds be subject to strict economic and fiscal policy conditionality, he stated.
Lastly, Mr. Moritz dealt with the future challenges of the EU. He remarked that the decisions made on 10th May appeared justifiable in light of the risks to the stability of European monetary union and the development of the global economy. However, he said, the decisions placed a very serious strain on the foundations of the monetary union, in particular with respect to the need for and the rationale behind sound fiscal policies.. Therefore, he mentioned, it was of utmost importance to reinforce the stability foundations on which the European monetary union has to be built. Restoring sound fiscal poli-cies among member states by strengthening the existing procedures of the Stability and Growth Pact was without alternative, he noted. Fundamentally, he stated, resolute action was necessary to stabilise and reinforce the weakened foundations of the monetary union so that similar escalations can be avoided in the future.