briefing note Why Berlin won’t back down on euro reform By Katinka Barysch ★ European politicians and central bankers have criticised Germany for wanting to construct a eurozone insolvency procedure at a time of crisis. Investors are so spooked by possible losses that they have driven Irish and Portuguese borrowing costs to record levels. Yet Berlin is unlikely to back down. ★ The Germans fear that a simple extension of the current, ad-hoc bail-out funds would fall foul of Germany’s constitutional court. They predict that setting up a permanent rescue fund without the option of insolvency would encourage reckless government borrowing and thoughtless investment decisions. They argue that preparations for the new mechanism must start now if it is to be up and running by 2013, when the current bail-out funds expire. ★ The debate about the new rescue and restructuring mechanism will be technically complex and politically divisive. The required treaty changes may not happen in time. Yet the other Europeans will have few options but to follow German leadership on eurozone reform.
On October 18th, Angela Merkel and Nicolas Sarkozy stunned their European partners – and most of their officials at home – by announcing the broad outlines of a deal on eurozone reform during a summit with Russia in the French resort of Deauville. Germany seemingly caved in on demands for 1 German officials deny that Merkel automatic sanctions to be added to the ‘stability and growth pact’, the EU’s fiscal made concessions in this respect. rule book.1 In turn, France agreed to back the German plan for a limited change They say that Berlin realised as of the EU treaty to set up a permanent ‘crisis 2 Charles Grant, ‘Europe dances early as September 2010 that a majority of EU countries would management mechanism’.2 This mechanism, said to Germany’s tune’, CER insight, oppose automatic sanctions. Merkel and Sarkozy, should include provisions for November 3 2010. an “adequate participation of private creditors”.3 3 In plain English: future rescue packages might involve a write-down of existing Statement for the FranceGermany-Russia summit’, debt. Ten days later, a summit of EU leaders made the idea official EU policy. The Deauville, October 18 2010. plan has caused political consternation and market panic. rd
th
Even before the Deauville deal, bond holders were well aware of the possibility that a struggling eurozone government may not be fully bailed out. Since early autumn, the ‘spreads’ (the difference between the borrowing costs of Germany and other countries) on Greek, Irish and Portuguese bonds had suggested that investors thought a default quite likely. But since Deauville, these spreads have widened 4 Greece already relies on a dramatically, to the point where Ireland was driven towards the eurozone’s separate S110 billion rescue existing rescue fund, the S440 billion European Financial Stability Facility (EFSF) package. that was cobbled together in May.4
Centre for European Reform 14 Great College Street London SW1P 3RX UK
T: 00 44 20 7233 1199 F: 00 44 20 7233 1117 info@cer.org.uk / www.cer.org.uk