Saturday 25 February 2017

Crucial ecofin meeting next week must find debt solution

AS eurozone finance ministers prepare for their Monday meeting in Brussels, they should reflect very seriously on what they need to achieve.

The new Portuguese programme is set to be launched in the context of a continuing lack of market credibility in the other two -- the Greek and Irish.

Therefore, the nations' finance ministers need to secure market credibility in all three programmes at once, and this will require an unprecedented degree of concentration and application to the task at hand. The usual rhetoric and recrimination must be minimised.

The ministers should first review their understanding of the workings of financial adjustment programmes.

The logic is pretty simple -- they are designed to give a country the breathing room to be able to make adjustments to the economy so that it will be able to bear the burden of the debt that caused the crisis in the first place as well as repay the extra money that they received.

Ultimately, these programmes are designed to allow debt to be repaid.

There are three core components to these programmes: First, the economic adjustment must be sufficient to secure future growth; second, the financial support must be sufficient to bolster the economy in the meantime; and, third, the financial terms must be such that the projected dynamics for growth and debt will render the debt sustainable. Debt cannot continue to grow forever in proportion to GDP.

With these fundamentals in mind, the ministers might then ask themselves three simple questions about the Irish, Greek and Portuguese programmes that are on the table.

First, why are they supporting these financial assistance programmes? Because, if they are not implemented, the non-payment of debt -- including bank debt -- by the nations on the periphery would lead to severe banking crises and a return to recession in the core of the eurozone.

They should explain these reasons honestly and clearly and avoid distracting rhetoric about European solidarity and such.

Second, do they want the programmes to succeed? This question may seem silly but, if the answer is yes, it implies that the ministers should take steps to promote the success of the programmes. Therefore, elements such as punitive interest rates that undermine the chances of success should be eliminated immediately. If programmes are designed to ensure that debt is repaid, the very notion of punitive interest rates is preposterous.

Third, how important is it that the programmes succeed? Obviously it is crucial. The success of the programmes is key to the survival of the euro and should, therefore, take precedence over any other European agenda. So any attempts to extract "concessions" from Greece, Portugal and Ireland that promote some other agenda but undermine prospects for growth are insidious.

The attempt to force Ireland to increase its corporate tax rate falls neatly into this category and will also simply distract from the main focus of the meeting.

The ministers have to get past such silly and self-defeating issues and concentrate on whether the current programmes are working. The rating agencies, the markets and most leading economists do not believe the plan is working. The opinion of the markets matters a lot because existing programmes depend on a return to market funding next year. The private sector is being asked to help fund the breathing space in Greece and Ireland, but the markets are refusing to do it as they don't believe in the dynamics of the programmes.

So the core issue facing ministers is simple. Are they willing to increase their financial commitment to these programmes to make up for the likely shortfall in private financing?

And are the European institutions willing to double-down their commitments in the belief that the projected debt dynamics are credible?

If the answer is yes, it is better to act earlier rather than later, because the private sector is already reducing its commitment to these countries -- in the case of Ireland, by withdrawing deposits from the banks -- and the shortfall in private funding will become larger as time passes.

In other words, the necessary commitment from the European institutions will only grow as decisions are put off.

In the case of Ireland, the gap is already being filled by the ECB.

If European institutions do not want to double-down, then the dynamics of the agreed programmes will not work and the debt is unsustainable.

In this case, some form of debt restructuring or rescheduling is required, and the cost of this exercise will also grow with delay.

It is time to face this central issue. Prevarication has made the likely cost to the European institutions much larger and this threatens to undermine public commitment in the core.

Prevarication has led to an exodus of private capital from countries on the periphery that is suffocating any growth prospects and undermining confidence and prospects for success.

This is a lethal combination that will leave attempts to save the euro bereft of public support. Next week's meeting of finance ministers is a crucial juncture -- it is time to concentrate and to keep the rhetoric to a minimum.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised various governments on macroeconomic policies.

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