Will There Be Political Will?
GIC Tokyo Manuel Balmaseda CEMEX Chief Economist
Political will will determine the outcome
Political economy dominating economic policy
1
Eurozone debt problem manageable
2
Austerity fatigue vs. Bail-out fatigue
3
Quo vadis Europe
4
Debt dynamics dependent on external factors
Europe does not have a larger debt problem than others Fiscal Balance
0.0 -2.0
1.0
-4.0
0.0
-6.0
-1.0
-8.0
-2.0
-10.0
-3.0
-12.0
-4.0
EMU
US
Current account balance
2.0
EMU
Japan
US
Japan
Debt by sectors
500 400
Corporate
300
Households
200 100
Public
0
Source: IMF
EMU
US
Japan
3
Europe does not have a larger debt problem than others Despite the vulnerable fiscal situation yields remain low in Japan and the US 5
Fiscal Balance (% GDP)
0
EZ -5
US
-10
JP
-15 0
50
100
150
200
250
Government gross debt (% GDP) Note: Size bubble: 10y yield average last 3 months. Fiscal Balance: average 2011-12. Gross debt: 2012
Source: IMF, ECB
4
Europe, the never-ending story?
5
Uncertainty as to whether Europeans want more Europe or not (actions speak louder than words) The Euro zone is currently in an unstable equilibrium
Bail-out fatigue vs. Austerity fatigue
Disintegration Resort to traditional tools (devaluation, strong monetary support) to alleviate the real effect (unemployment) of the needed adjustment. High costs (default, banking linkages, fear of floating)
Enhanced integration • Short-term easing • Mid-term reforms • Long-term integration and redistribution
Implies loss of sovereignty
Current crisis, the necessary trigger to push forward the European Project
Political game: playing with fire
1
A game of chicken
2
Towards a “new” Euro
Core Europe forces other countries to undertake the necessary adjustments and reforms
Periphery countries know that the break up of the Euro would be a catastrophe for everybody, including the core
Will Spain and Italy belong to the “new” Euro?
7
Emerging crisis in mature(?) economies • Unfinished project: • Incomplete institutional framework
• Political dynamics will set the speed, scope and timing of resolution • Address linkages between sovereign debt and banking solvency • From private exposure to private exposure, thanks to the ECB • Need for a transfer union in the long run, only possible with integration • Four roads to debt reduction: • Primary surplus: frontloaded fiscal policy • Lower interest rates: markets penalizing, not rewarding, fiscal discipline • Economic growth/inflation: ECB action required, at least, in the short term • Restructuring/default 8
The European crisis is not a fiscal crisis, but a political crisis
Overall fiscal deficit (% of GDP)
Fiscal tighteninng (% of potential GDP)
10
6
8
5
2012
2013
4
6
3
4
2 1
2
0
0 SPA
GER
FRA
UK
IT
-1
US
SP
60
6
50
5
40
4
30
3
20
2
10
1
0
0
GER
Source: IMF, “Fiscal Monitor” Oct. 2012
FRA
UK
IT
IT
IR
FR
NL EA17 UK
US
DE
Debt service (% of GDP)
General government expenditure (% of GDP)
SPA
PT GR
US
SPA
GER
FRA
UK
IT
US
9
Beware of coordination, it can add up to your troubles Fiscal Multiplier Variants 1.5 1 0.5 0 -0.5 T+RP+NC
T+NRP+C
GI+RP+NC
GI+RP+C
GI+NRP+NC
Composition: T (Taxes Oriented) or GI (Gov expenditure/investment Oriented) Risk Premium: RP (decrease in risk premium) or NRP (stable risk premium) Coordination: C(Coordinated) or Non Coordinated (NC) Source: Cemex Economics
GI+NRP+C
Sudden stop of flows: Whose currency is the Euro? Despite the vulnerable fiscal situation yields remain low in Japan and the US 5
Fiscal Balance (% GDP)
0
GER
FI
IT
BE NL
PT
FR
-5
SP
GR US
-10
JP
IRE
-15 0
50
100
150
200
250
Government gross debt (% GDP) Note: Size bubble: 10y yield average last 3 months. Fiscal Balance: average 2011-12. Gross debt: 2012
Source: IMF, ECB
11
ECB has been quite active, even as official rhetoric has not been as forthcoming until recently ECB has compensated the disruption of European money ECB announces markets … new liquidity measures
3200000 2800000
… and it has allowed for a reduction of Euro area exposure to periphery countries: private borrowing is being replaced by public sector flows
Lehman
2400000 Total Claims
2000000 1600000
Gold and Other Assets
1200000 Lending to Credit Institutions
800000 400000
Securities
May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12
0
Source: IMF, Global Financial Stability Report, Oct 2012
ECB balance sheet (M€)
12
Cross-border private capital is being repatriated from the periphery back to the core Germany continues being the main lender, but now through public sector flows 500
400
Change in Bundesbanks´s claims on the Eurosystem (TARGET)
300
Current account balance
200
100
0
-100
Net capital flows excluding TARGET
-200
Source: Bundesbank
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
-300
Source: IMF, Global Financial Stability Report, Oct
13
Measures focused only on the short run are, by definition, short-lived
1
Prevent sovereign default (mainly in Spain and Italy)
2
Prevent banking defaults from being systemic
3
Sustainable fiscal accounts (does not imply frontloaded consolidation)
ECB buying time
• Short run: to avoid a liquidity crunch, financing needs (spreads)
• Long run: integration and sustainable growth 4
Banking restructuring pre-”banking union”
• Downsizing • Denationalization and competition • Too big to fail implies externality risks
Need to act in the short run vs. “real” moral hazard
ECB intervention buys time
Financing costs back to beginning of the year levels ECB
9.0
440
8.0 7.0 SPA
6.0 5.0
Risk perception reduced after ECB announcement 390
Sovereign
340
Financial
290
Corporate
ECB
IT 240
4.0
FRA
3.0
190
Source: Bloomberg
Nov-12
May-12
Nov-11
May-11
Nov-10
May-10
Nov-09
May-09
Nov-08
May-08
Nov-12
Aug-12
May-12
Feb-12
Nov-11
40
Aug-11
0.0
May-11
90
Feb-11
1.0
Nov-10
140
Nov-07
GER
2.0
Markit Itraxx Sovereign, Financial and Corporate Index
• Default risk • Break-up risk (exchange rate risk) 15
Europe continues buying time strategy, long-term strategy? Institutional reform/Fiscal reform • Lender of last resort (ECB) • Fiscal integration (European Treasury) and Eurobonds
Incentive mechanisms (fiscal, regulatory, etc.) Banking Union • Pan-European banking resolution • European Deposit Insurance Institution • Regulation and supervision
Structural reforms across Europe, predominantly in the periphery (competitiveness) but not only
Dominance of domestic politics (German & Italian elections) Diminishing returns to the “buying time” strategy Sovereign as reference for corporates (not a leveled playing field) Increasing social risk 16
Credibility can drive positive dynamics …
Virtuous Credibility Cycle (Euro Accession) End of 1994 Recession Central Bank independence + Fiscal Consolidation plan
Credibility Gains
Deficit Reduction (primary) Debt Yields Decrease > Deficit Reduction (primary & interest) Interest rates decrease Higher GDP Growth Low FX rate volatility
> Improved Fiscal Balance
Implied Probability of EMU Accesion 100 90 80 70 60 50
France Spain Portugal Italy
40 30 20 10 0 Jun-96
Sep-96
Dec-96
Mar-97
Jun-97
Sep-97
Dec-97
Mar-98
Source: JPMorgan
Credibility “matters” and can deliver good results in the very short term 17
… but it can also drive negative ones
Vicious Credibility Cycle (Self-Fulfilling Debt Crisis) Markets sells Sovereign debt
Government Debt under prolonged GDP slowdown, Higher Interest rates & Contingent Liabilities Shock (% GDP)
Yields & Cost of Debt rise
Credibility Worsens
Debt Interest payments Rise Debt “mark to Market” hits bank balance sheets > Primary Budget adjustments Lower GDP Growth
Budget Positions Deteriorates Initial adjustments non credible + rating worsens
Alternative Scenario: 2% lower Growth + 200 bp increase in real interest rates + increase in cost of Guarantees. Source: IMF
18
Don’t despair, “el dorado” is at the end of the road
Thank you!