The two key leaders of the euro zone issued an ultimatum to the European Union (EU) governments on Monday, saying they must decide by the end of the week whether they will allow greater centralised oversight over their national budgets, effectively giving up some of their fiscal sovereignty. Hot on the heels of this announcement came rating agency Standard and Poor’s (S&P) unexpected warning of a mass credit downgrade of euro zone countries if EU countries fail to come up with a firm agreement to tackle the financial crisis by Friday, as well as the Asian Development Bank's (ADB) trimming of projected East Asian economic growth.
Germany, France to press for greater EU integration
German Chancellor Angela Merkel and French President Nicholas Sarkozy said they would together push to remake the EU into a more integrated political and economic federation. The two euro zone leaders are meeting in Paris at the start of a critical week that will conclude with a EU summit meeting on Thursday and Friday. They have called for amendments to European treaties that would include greater centralized monitoring of budgets and automatic sanctions against countries that infringe upon stricter rules on deficits, curtailing the amount of debt national parliaments can issue. These changes would effectively subordinate economic control to collective discipline administered by European technocrats in Brussels.
Should some countries decide not to participate, the 17 countries in the euro zone will move ahead with a more integrated union by signing a new compact outside EU treaties, the two leaders said.
The German and French leaders also made a commitment not to pressure private investors into accepting voluntary losses on euro-denominated bonds, a main part of Greece's second bailout that is still being negotiated, marking a shift on the part of Germany from previous plans to ensure private-sector participation in any future bailout agreements. While the commitment is not binding, it shows that Germany is recognising the damage its insistence on private-investor participation has done to investor confidence.
Mr. Sarkozy and Ms. Merkel have taken two major gambles. Firstly, the proposal risks dividing the 17 eurozone countries and the 27 EU nations, some of which are likely to reject such intrusive budget oversight from Brussels. It is also unknown how well national parliaments and voters within the euro zone will accept these changes.
Second, it is uncertain how such promises of action will be received by markets, which have been testing the resolve of European leaders for months. Markets initially responded positively on Monday with stocks and the euro gaining points, but those gains were lost after S&P put 15 European nations on credit watch.
The two leaders are aiming to foster agreement among the other members of the euro zone that they will press forward with new treaty, and appear to be calculating that such a show of unity will be sufficient to persuade the European Central Bank, the only institution in Europe with enough financial power to defend the ability of member states to raise money on bond markets, that it has enough political clout to better protect vulnerable countries like Italy and Spain.
Mr. Sarkozy said that France and Germany aim to have the treaty amendments drafted and agreed upon by the end of March next year, but ratification is expected to take even longer. The process of ratification is even more complex. For example, should Ireland decide to hold a referendum on these changes, the process will be slowed further. Ireland previously rejected the last European treaty in a referendum, before being forced by European counterparts to vote again.
Voters may also be wary of “more Europe,” with their growing disaffection becoming stronger than their concerns over the fate of the euro.
Report: Sarkozy and Merkel Push for Changes to Europe Treaty (New York Times, 5 Dec 2011)
Report: Europe at Crossroads (Wall Street Journal, 6 Dec 2011)
S&P puts euro zone countries on credit watch, warns of downgrade
Germany and the euro zone’s five other triple-A members face having their top-notch ratings downgraded after S&P put 15 countries in the single currency bloc on negative creditwatch.
S&P has warned that euro zone countries including Germany, France, Austria, Finland, the Netherlands and Luxembourg were under review, but added that it expected to conclude its review “as soon as possible” following this Friday’s summit. It warned that all of the six triple-A rated governments that their ratings could be reduced to AA+ if the creditwatch review failed to convince its experts.
Markets have been expecting a potential downgrade of France, but few anticipated the same for Germany. S&P said regarding Germany that it was anxious about “the potential impact ... of what we view as deepening political, financial and monetary problems with the European economic and monetary union.” S&P told governments, “It is our opinion that the lack of progress the European policymakers have so far made in controlling the spread of the financial crisis may reflect structural weaknesses in the decision-making process within the euro zone and European Union.”
S&P’s move at such a critical time is likely to fuel further accusations by politicians of rating agencies worsening the crisis.
Rating agencies are also concerned about who will fund any euro zone solution with many plans likely to heighten the strain on triple-A countries. Governments on the other hand are concerned that a downgrade will make it harder for the euro zone bail-out fund, the European Financial Stability Facility, to arrange financing in the markets for its packages for Ireland, Portugal and Greece, as it is underpinned by guarantees from the six triple-A rated nations, and raise their own financing costs.
S&P also said there was a 40 percent chance that the output of the euro zone as a whole would shrink next year, highlighting the difficulties faced by European economies in trying not to choke off economic growth with large amounts of austerity.
Meanwhile, Italy’s costs of borrowing went down after its new government announced an austerity program. Such a move offered a glimmer of hope that the bloc could stop the financial contagion.
Report: S&P warns eurozone of mass downgrade (Financial Times, 5 Dec 2011)
Report: S&P piles pressure on EU budget plan (Reuters, 5 Dec 2011)
ADB: East Asian economies at risk from euro zone crisis
The ADB has reduced its 2012 growth forecast for emerging East Asian economies including China, as the euro zone crisis continues to threaten the global economy.
The ADB cut its GDP growth forecast to 7.2 percent for ASEAN plus China, Hong Kong, South Korea and Taiwan, from 7.5 percent in September. In its regional economic update, it also projected an “extreme scenario” of a European and US meltdown, which could reduce East Asian growth, including Japan, by 1.2 next year from an original forecast of 5.4 percent to 4.2 percent, according to ADB officials.
With “economic headwinds blowing out of Europe”, the ADB said its “cautiously optimistic” outlook for the Emerging East Asia region excluding Japan was in the context of increasing economic afflictions compared to its September forecasts. It added that “major downside risks” included a deep recession in Europe and the US, greater protectionism and continuing inflation.
If the euro zone's woes blow up into a global crisis, the effect on East Asia would be “serious yet manageable” as long as governments responded decisively and cooperatively.
“Emerging East Asia must prepare for a prolonged crisis and weak post-crisis recovery by implementing appropriate short-term macroeconomic responses and pursuing necessary long-term structural reform,” the report said, adding that government expenditure could help maintain growth while central banks would have to skilfully manage monetary controls to keep inflation in check.
Report: East Asian economies face eurozone headwinds: ADB (AFP, 6 Dec 2011)