The objective of the recent European Union Head of States meeting was to help overcome the Sovereign Debt Crises facing the PIIGS (Portugal, Italy, Ireland, Greece, Spain) which has threatened to destabilize other European Union countries as well.
Currently the European Financial Stability Facility (EFSF) and European Financial Stability Mechanism(EFSM) are temporary emergency purpose vehicles meant for helping out the defaulting economies by giving loans. EFSF had a cash pool of € 440 Billion, while EFSM has the authority to raise upto € 60 Billion from the capital market. The guarantee capacity of EFSF of € 440 Billion was increased to € 780 Billion in the EU meeting on July 21 this year, so that the lending capacity is now € 440 Billion. From what I understand the logic is that the EFSF will be raising money from the capital market by issuing bonds, and because the bonds are guaranteed by this guarantee amount of € 780 Billion from AAA rated countries, the borrowing would be easy and at low interest rate. The lending capacity is the maximum amount that the EFSF can raise. The difference between EFSM and EFSF is that collateral for EFSM is the budget of the European Union, while that for EFSF is the guarantee capacity pooled from Eurozone member states(Germany contributes 27% and France 20% to this fund, so that in the event of sovereign default their economies will be hit very hard).
EU Council President Herman Van Rompuy has in his statement said that “our first approach to Private Sector Involvement, which had a very negative impact on the debt markets, is now officially over”. This I think means that the EU will no longer force the Banks to reduce their debt amount payable by Greece.
One of the agenda of the meeting was to speed up the creation of European Stability Mechanism, a permanent rescue funding programme to replace the temporary EFSF/EFSM. ESM will also have a lending capacity of € 500 Billion.
Also, EU member countries will make bilateral agreements with IMF such that the 27 bilateral agreements will provide a total loan of€ 200 Billion from the national central banks, that can be channeled to the crises-ridden economies. This route is being taken because European Central Bank(ECB) cannot directly bail out EU economies by providing them money, and even the route currently taken to channel money through IMF is likely to face opposition from ECB president Mario Draghi.
To ensure that this bailout mechanism, which requires a considerable cash guarantee from EU member states, succeeds, EU countries will have to submit to stronger budget deficit regulations. This common set of Budget deficit regulations is set to bring the EU economies in a closer fiscal union than before. Some of the regulations are:
- In the event of an economic recession, budget deficit should not exceed 3.0% of GDP. Nations failing this will be subject to sanctions
- Public Debt is not to exceed 60% of nominal GDP
- Budgets must be balanced in structural terms over the economic cycle( which means that the governments must AIM to have balanced budgets over the period of the economic cycle)
- Automatic Adjustment mechanism to ensure correction in case of deviation must be defined by member states
- Bringing revised Qualified Voting Majority in the Council to decide on Commission proposals at the very beginning of the Excess Deficit Procedure so that this will apply throughout the procedure – this means that an 85% majority in EU is sufficient for decision making even if the ECB does not agree.
- Member States under an Excessive Deficit Procedure will have to submit their draft budgetary plans before adoption to the Commission.
All EU nations, including Britain, agreed to these requirements. However it was the implementation, which required a stronger economic and monetary union, which was not acceptable to Britain. Britain’s financial services industry contributes to about 10% of its GDP – if the European Central Bank has the power to override the authority of the England Central Bank the protective regulatory environment could damage the industry. It is for this reason that David Cameron refused to join the new fiscal compact. The countries joining in the fiscal compact are the 17 Eurozone countries, and 6 other countries, while Sweden, Hungary and Czech Republic will confirm after some time. A Fiscal Compact Treaty will be signed, sometime in March 2012 to make the fiscal compact binding.
Some interesting links for further reading:
Image credits: monstersandcritics,com, reuters.com
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