Criticise it all you want, Germany is not going to drop austerity

Writing on his Telegraph blog, Open Europe Director Mats Persson argues that anyone who prays for Germany to U-turn on its eurozone policy after the September election will probably be left sorely disappointed.

Read the full article below:

"Fuelled by an intensified wider debate about the merits or otherwise of austerity as a remedy to economic problems, the last few weeks have seen politicians, commentators and economists coming out in droves to criticise Germany’s austerity-for-cash approach to the eurozone crisis.

The new Italian Prime Minister Enrico Letta – who is today meeting his German counterpart, Angela Merkel – said yesterday that Italy “will die of fiscal consolidation alone”, leading some to conclude that Italy will lead the revolt against austerity in the Eurozone.

Everyone is now looking ahead to the German election in September, with the idea being that with election season gone and perhaps with a Conservative/Social Democrat "grand coalition" at the helm, Germany will flinch and drop the whole austerity thing.

Unlikely. We might see some easing of targets and toned down rhetoric, but no fundamental shift. The German consensus on austerity runs incredibly deep.

Although, strictly speaking, in Germany, austerity is actually not called austerity at all (it sounds “evil” as Angela Merkel has pointed out). Instead, the term used is sparkurs (savings course) or sparpolitik (savings politics). Or as a verb; Hausaufgaben machen – to do your homework. The opposite is schuldenpolitik (debt politics) or Schulden machen (to make debt).

Such semantics matter. Fundamentally, they illustrate that the perceived dichotomy between ‘austerity’ and ‘growth’ – which strikes a chord with some other electorates in Europe – is a non-starter in Germany. It would be electoral suicide for a German politician to advocate schuldenpolitik – akin to an American Presidential candidate professing himself an atheist or a Swedish politician denying climate change (the latter would most likely also involve being stripped of one’s Swedish passport). This logic drives politicians’ approach both at home and abroad.

By and large the main opposition party, the centre-left SPD, does not advocate a radical departure from Merkel’s blueprint. Instead, it merely nit-picks at the edges while garnishing the whole exercise with concerned rhetoric about the social consequences. A typical SPD critique is that expressed by Nils Schmidt, the leader of the Party in Baden-Württemberg: “We have to make cuts, but step-by-step, we can’t make them all at once.” The key there is “we have to make cuts”. And remember, in an effort to be seen as tough on irresponsible banks it was the SPD that was the most hawkish over Cyprus. Even the Green party is keen to be seen as fiscally responsible taking a tough line on paying down public debt.

German opinion polls have also consistently backed the austerity-for-cash approach abroad with a recent opinion poll showing that 65 per cent said they agreed with Merkel’s handling of the crisis – up from 46 per cent in July 2011.

In other words, even under a grand coalition between Merkel’s CDU/CSU and SPD, the basic course in Germany’s Europe policy will remain fairly steady. Crucially, the complicated sequencing for any further eurozone integration – such a resolution fund for banks or public debt pooling – will likely stay broadly the same: constitutionally-anchored eurozone-wide supervision first, cash later. This also means that Franco-German axis will continue to suffer from tensions.

There is, of course, an intense debate going on within Germany over the country’s position in Europe – and a worry about being seen as the neighbourhood bully. As I’ve argued previously, the crisis sees Germany’s two post-war pillars clashing head-on – firm commitments to both Europe and sound money.

Exactly how this debate will play out remains unclear. However, anyone – say a French socialist – who prays for Germany to U-turn on its eurozone policy after the September election will probably be left sorely disappointed."

Not everyone in François Hollande's party cares about Franco-German diplomacy...

French President François Hollande's Socialist Party will hold its 'Convention on Europe' in Paris on 16 June. Several working papers are currently being prepared as a basis for discussion among party members and supporters at the Convention. One of them has been leaked to Le Monde. And believe us, it contains some pretty strong stuff.

Two caveats before we start:

• We learn from the official website of the Convention that the papers do not reflect party policy "at this stage".

• The draft published by Le Monde could still be tweaked before the Convention.

Nevertheless, it does give a sense of the mood within the party. These are arguably the most 'explosive' excerpts:

"The communitarian project is today wounded by an alliance of circumstance between the Thatcherite rhetoric of the British Prime Minister - who only conceives a devalued à la carte Europe - and the selfish intransigence of Chancellor Merkel - who cares about nothing but the savings of depositors across the Rhine, Berlin's trade balance and her electoral future. In this context, France has today the only genuinely European government among the EU's big member states."

"Democratic confrontation with the European right means political confrontation with the German right. Franco-German friendship is not the friendship between France and Chancellor Merkel's European policy."

"[Former French President Nicolas] Sarkozy had imposed a certain practice: not Franco-German friendship, but France's alignment to Germany."

The document concludes the party should stand behind President Hollande and support him "in his arm wrestling against the austerity Chancellor [yes, it's Angela again] and the European Conservatives."

It's hard to imagine the French government or Hollande himself publicly endorsing this document, but the sense of frustration is palpable and points to the widely recognised relative decline of French influence over both the direction of the 'Franco-German motor' and the EU more widely. It signals the mood within Hollande's party is becoming increasing hostile to Mrs Merkel, and that the party wants the President to be tougher in confronting the German Chancellor. Not a call Hollande can keep ignoring forever. But also a fight, deep down, he knows he is probably not going to win.

Italy's new Prime Minister: Pro-EU integration, anti-austerity?

We've detected strong demand for a quick profile on Enrico Letta, who has just been appointed Italy's new Prime Minister. With the debate raging over the wisdom or otherwise of German-style fiscal discipline in the eurozone, the big question is: is Letta against austerity? Here's a short bio:

• Letta is from Tuscany and will turn 47 in August. This means he's in line to become Italy's third-youngest Prime Minister ever. 

• He holds a PhD in European Law, and was appointed Europe Minister in 1998. At the time, he was 32 - which made him the youngest Italian minister ever. He also served as Industry Minister under Massimo D'Alema.

• Letta was an MEP between 2004 and 2006. 

• He's been the deputy leader of the centre-left Democratic Party since 2009.

• Importantly, he is a big AC Milan fan - which could help him win support from Silvio Berlusconi. Well, perhaps along with the fact that Enrico Letta is the nephew of Gianni Letta, Il Cavaliere's closest aide. 

So what about his political views and that key austerity point?

In his press statement after the meeting with President Giorgio Napolitano, Letta said Italy should be

"firmly committed to changing the direction of EU [economic] policies [which are] too focused on austerity, which as European Commission President [José Manuel] Barroso said the other day are no longer sufficient."

(Hallo, Angela!) 

And remember that when the EU won the Nobel Peace Prize, Letta tweeted the award should be

"a spur to be prouder, more concrete and effective in our pro-European stance. There's no future without the United States of Europe." 

This goes to show he is strongly in favour of more EU integration (though admittedly so are a majority of Italian politicians). In other words, Napolitano has appointed a Prime Minister with solid European credentials and who can credibly argue for an easing of austerity in the EU. Quite smart. 

Crucially, Letta also stressed the new government won't be formed "at any cost". This can be seen as a warning to Silvio Berlusconi not to set out too tough conditions for lending his support. However, it's worth bearing in mind that Berlusconi's centre-right alliance is ahead in all opinion polls - meaning Silvio is in a position of strength right now.

Letta will hold talks with all other political parties tomorrow. If things move on smoothly, we should have the list of ministers by the end of the week. Follow us on Twitter @OpenEurope and @LondonerVince for further updates from Italy. 

Public support for the EU drops by 16% in one month: is popular support for the euro in Greece finally about to wane?

As we've noted in the past, a factor that will determine whether the eurozone can hang together in the long term is the extent to which the public in the South begins to see the euro and EU austerity as synonymous.

For example, despite everything that has taken place in Greece, this has not been the case, with a majority of Greeks consistently in favour of remaining inside the euro. The choice is instead perceived as being between austerity or some form of alternative. This is why we rightly predicted that Greece would remain inside the euro following its hectic dual elections last year (at a point when many analysts were predicting an imminent Grexit).

But is this now starting to change? 

Possibly.

A new Public Issue poll shows that 66% of Greeks now have a "negative opinion" about the EU. For a country that has traditionally has been staunchly pro-EU, that's bad enough. But extraordinarily, when the same question was asked only a month ago, 'only' 50% of respondents said that had a negative opinion  about the EU- a massive 16% increase in only a month, possibly owing to the handling of the Cypriot bailout and the renewed Troika push for civil service cuts in Greece. Those with a positive view dropped from 48% to 31% in the same space (see the graph below).

A separate poll by Marc for Alpha TV asked the question, “In case it’s not possible to improve the conditions of the loan agreement, what do you think we should do?” 53.8% answered "remain in the EU and the euro", while 41.3% said they wanted to "leave the EU and return to the drachma" (4.9% don't know). Note that this was a question about leaving the EU, not only the eurozone. Whilst still a majority in favour of sticking around, to our knowledge, there has been no Greek opinion poll to date with such a large share in favour of leaving the euro and the EU.

Incidentally, the Public Issue poll also asked who respondents wanted to see as Prime Minister. Top candidate? “None”. (see graph)

We're not drawing any firm conclusion from this, although if this trend continues it will be significant. Currently a majority of Greeks believe that things "would be worse" outside the euro. It's worth listening to our interview with leading German economist Hans-Werner Sinn, which we published today, on the prospects for Greece in the euro. One thing is clear: this won't be easy.

Is the academic premise for austerity in the eurozone crumbling? Not quite…

A mini-storm has been whipped up in the economic community overnight after a paper was published highlighting some flaws in the widely cited Reinhart & Rogoff paper ‘Growth in a time of debt’.

A quick recap for those of you not familiar with the paper. It essentially argues that high debt levels are associated with low economic growth. It bases its analysis on data from 44 countries over the past 200 years. It also notes that this relationship gets stronger once debt exceeds 90% of GDP. The paper has been widely cited in defence of and in support for ‘austerity’ – by politicians in both the US and Europe (notably Olli Rehn in respect to the eurozone crisis).

The new research released challenged Reinhart & Rogoff’s (R&R) findings, on the basis of an excel error (oops), data omissions and incorrectly weighting of data. There has been plenty written about which side is correct – you can see a summary of criticisms here and R&R’s responses here and here.

The question that interests us is not necessarily the intricacies of this academic back and forth. To be honest, it is obvious that there is no clear single threshold above which debt begins to impact growth in all countries and that often specific historical experiences in certain countries may not mean much for policies in different times and places (see this Ed Hugh post for a good summary). This is particularly true given some of the unique constraints of the eurozone crisis.

But given that some people are seeing this as a damning indictment of the backing for ‘austerity’, will this have any impact on the approach to the eurozone crisis?

In a word, no. Here are a few reasons why:

• R&R research aside it is clear to everyone that Greece, Portugal and Ireland were insolvent, it was market pressure that pushed them into a bailout. Reducing the debt level is a vital part of their reform, while it also serve to counter the significant moral hazard that comes with a bailout.
• Similar constraints apply in Spain, Italy, Cyprus and Slovenia. With elevated borrowing costs they cannot expand fiscal policy without coming up against greater market pressure and pushing their average interest costs well above their growth rates (especially in the short run).
• Therefore, arguing for the end of austerity in these countries is actually arguing for fiscal transfers from the rest of the eurozone, since they do not have much, if any, room to expand spending. This is ultimately where the debate is at, it is not about austerity or spending, it is about whether the stronger countries are willing to provide the transfers – be it through banking union or fiscal union – to keep the eurozone together in the longer run and create the architecture necessary so that it can withstand future shocks. If they are not then they have to face the prospect of breaking up or decreasing the size of the eurozone.
• The constraints which apply also extend much further than just public debt. As we have seen in Spain, Ireland and Cyprus (and are seeing in Slovenia) the levels of private sector and banking sector debt are equally important. The macro picture is much more complex than just the level of public debt and economic growth. The problems in the crisis are a mix of fiscal, banking and structural.
• Austerity is more than just cutting spending. It has become a catch-all term for some very necessary reforms to improve competitiveness and productivity in the eurozone. Even if spending could be increased, these reforms would be needed, although admittedly the fallout (increased unemployment in many cases and massive political backlash) might be more bearable – but as noted above, this isn’t really possible in many of the worst cases.
• The logic behind the current approach is also strongly driven by Germany’s own economic experience in the late 1990s and early 2000s, which proved very effective in turning the country around. The main issue here is not whether the approach itself is correct or not (since it clearly did work there), but the scope in which it is applied. It is clear that you cannot have 17 Germanys with economies driven by exports in a single currency bloc where the countries predominantly trade with each other (it might help in the short term but its not clear it is a sustainable long term economic model for the bloc).

So what academics (and policymakers) really should debate is whether fiscal transfers are possible and/or desirable.  Proving or disproving R&R is neither here nor there when it comes to dealing with the eurozone crisis.

Yet again the eurozone crisis is butting heads with national democracy

After a lengthy absence Portugal returned to the headlines over the weekend with the Constitutional Court ruling that some of the government austerity measures were unconstitutional. Here are the key details:

• The court found that four out of nine key savings measures included in the government’s latest budget were unconstitutional. These measures focused on cuts to public sector wages and pensions – the court deemed these unconstitutional since they hit public sector workers disproportionately hard. They also ruled against cuts to unemployment and sickness benefits.
• The measures amount to savings of €1.3bn (0.8% of GDP) which will now need to be found elsewhere. If they are not found, then Portugal’s deficit this year could reach 6.4% rather than the 5.5% currently targeted.

What does this mean for Portugal and the eurozone?

• The ruling was the cherry on top of a bad week for the government after a close ally of Prime Minister Pedro Passos Coelho resigned and the government faced a no-confidence vote in the parliament. Fortunately, it has so far survived these problems (new elections would bring huge uncertainty) but its support continues to be eroded.
• The previous political consensus in favour of the bailout and the accompanying austerity has now vanished, the opposition is likely to become increasingly vocal in its anti-austerity approach.
• The Commission has warned that the extension of the bailout loans agreed recently will be under threat if the government does not meet its targets.
• The cuts are likely to be found elsewhere but they may have more of a negative impact on growth, although this remains uncertain. One thing that is clear is that the public sector wage and pensions do need to be adjusted if Portugal is to become competitive and particularly if it is to recover through export led growth as the bailout programme currently targets. The inability to adjust these areas could harm Portugal in the long run.
• That said, this is not the first time this has happened. Last July, the court made a similar ruling on public sector wage cuts. The fact that this has happened again suggests the government may be struggling to find savings elsewhere (why else push on with cuts it knows stand a good risk of being blocked), and doing so may take longer than some expect.
• Legal points aside, experience (particularly in the Baltics) suggests that wage cuts in the private sector often follow or go hand in hand with public sector ones – at the very least, buy-in is needed across the economy and the private sector is unlikely to lead such an adjustment unless prompted to (wages are sticky on the downside). In this sense, although the cuts may have disproportionately hit public sector workers initially it may be necessary part of the internal devaluation approach taken (whether this approach is correct or not is another question).
• And of course, this adds further delays and uncertainty in the eurozone – along with lack of government in Italy and capital controls/bailout in Cyprus.

This is likely to rumble on for a while yet as the Portuguese government searches for savings elsewhere which will meet the requirements of the troika. Yet again, the eurozone crisis is butting heads with national democracy, in this case specifically constitutionality. Plenty more of that to come we expect.

Where will Cypriot growth come from?

This is now emerging as the key question for Cyprus following the severe mishandling of its bailout. The financial services sector, along with real estate and related businesses, which accounted for around 30% of Gross Value Added in the economy is now essentially gone as a source of growth.

Cyprus’ main trading partners, Greece in particular, remain mired in recession. Its two largest banks – key employers – will be restructured and unemployment will undoubtedly rise. Meanwhile, the government will be cutting spending and raising taxes, laying off public sector workers and embarking on some strict labour and product market reforms – as part of the standard Troika bailout package. Many of these reforms are needed but as we have seen across Europe, when combined with other impacts mentioned above, a downward spiral can be created.

The key hope for growth remains tourism. However, with the euro remaining strong and the prospect for political and social unrest in Cyprus still high, it is difficult to see a huge boost in this area. It will continue to truck along but is unlikely to fill the gap left by other areas of the economy shrinking. As we have discussed before, the prospect of growth from large gas revenues remains a pipe dream for now.

With all of this in mind we have put together a comparison of some of the previous growth estimates, along with the implicit ones included in the latest troika report and some of OE’s initial (optimistic) projections (click to enlarge).

All of this remains uncertain, depending on when capital controls are removed and how investors respond but it does not make pretty reading. All previous hopes for the economy are off the table and expectations need to be severely adjusted. The Troika's estimates are very optimistic, particularly in terms of returning to rapid growth in 2015 and 2016. Furthermore, if the growth estimates included in the bailout prove to be overly optimistic it means Cyprus will, just as Greece did, require further financial assistance.

Details of Cypriot bailout agreement filtering through

The package is coming together. The IMF has officially announced that it will take part in the Cypriot bailout, providing €1bn of the total €10bn in loans - that gives a UK share of around €50m (see our thoughts here on UK IMF shares). That leaves €9bn to be provided by the eurozone, likely through the ESM. Below we breakdown the country shares (click to enlarge):

Other details of the Memorandum of Understanding (MoU) filtering through include:

• 2.5% interest rate on the loan, with a 10 year grace period on repayments, it will then be repayable over a 12 year period (repayments start in 2023 and finish in 2035).
• 4.5% in cuts/savings to be found before 2018 (on top of the 7% already scheduled by 2015) to drive Cyprus from a 2.4% primary deficit now to a 4% primary surplus in 2018 (two years later than previously envisaged).
• The figures given in the MoU leaked yesterday (which reports suggest are the same in the final agreement) imply an 8% contraction in GDP this year and 3% next year. This seems optimistic and could be closer to 10% and 5% respectively, if not worse, but ultimately depends on how long the capital controls are in place for.
• Eurozone officials will review the agreement tomorrow, with a final proposal to be presented on 9 April, which eurozone finance ministers are expected to approve at an informal Eurogroup meeting in Dublin on the 12 April.
• The Bundestag could vote on the deal around the 15 April. IMF board expected to approve the deal in early May.
• First tranche of bailout funds expected in early May, ahead of debt maturing at the start of June which Cyprus needs to pay off.

A few hurdles left to jump then in terms of approval from national parliaments – which is no mean feat given that the figures underpinning the bailout are likely to come under some well-deserved scrutiny.

A turbulent Easter in Cyprus

Uncertainty continues to reign in Cyprus. Cypriot Finance Minister Michalis Sarris resigned this afternoon, seemingly confirming the earlier (denied) rumours that he had previously tried to resign and bringing to a close what must be one of the shortest stints as finance minister in recent history (35 days). To add fuel to the fire, initial reports suggest he resigned due to the on-going investigation into people moving funds out of Cyprus ahead of the bailout. Fortunately, unlike other aspects of the crisis, the Cypriot government has wasted no time in appointing a successor with Labour Minister Haris Georgiadis already lined up to fill the role.

Meanwhile, as we noted in today’s press summary (and have repeatedly suggested) the capital controls look set to last for much more than a week.We also highlighted some interesting comments by the President of the Cypriot Parliament Yiannakis Omirou who said:

“I would like to send a message to the Cyprus people that there is no other way, there is no alternative apart from freeing (the country) from the troika’s and the memorandum’s bonds…by leaving the troika and the EMS behind us, we will ensure our national independence, our national sovereignty, our moral integrity and our economic independence…If we remain bound by the Troika and the memorandum Cyprus’ destiny is already foretold and there will be no future.”

Clearly not one to mince his words.

Furthermore a draft version of the loan agreement between the EU/IMF/ECB Troika and Cyprus (the Memorandum of Understanding) was leaked yesterday. It drove home another point which we have flagged up before. Despite all the talk about depositors and banks, Cyprus is still getting a €10bn bailout, that will mean undergoing the fiscal consolidation and structural reforms (widely referred to as ‘austerity’) witnessed in the other bailout countries. The key points of the agreement confirm this:

• 7.25% of GDP in fiscal consolidation between 2012-2016.
• Freeze in public sector pensions and a two year increase in the retirement age.
• Implement a four-year plan as prepared by the Public Administration and Personnel Department aimed at the abolition of at least 1880 permanent posts over the period 2013-2016.
• Increase the statutory corporate income tax rate to 12.5%.
• Increase the tax rate on interest and dividend income to 30%.

These are but a few of the measures and the document remains incomplete. The impact on GDP is likely to be significant, while youth unemployment is already at 31.8% (total at 14%) – this is likely to rise substantially.

To add to all this, reports continue to abound about outflows of deposits before the bailout, while the banks were closed and people now trying to skirt the capital controls. Significant questions are being asked about the enforcement and implementation of all these rules. With a decision on whether to extend capital controls expected on Wednesday evening or Thursday morning the uncertainty is likely to continue.

The inbuilt political stand-off in the ECB's bond-buying programme

One of the many sub-stories of the Italian election is how it calls into question the ECB's bond-buying programme - the Outright Monetary Transactions (OMT). Not so much because of the ECB's ability to expand its balance sheet and stand behind Italy and Spain (though there's a clear cost to that). The reason is another one: unpredictable politics.

This is something we highlighted immediately following Mario Draghi's announcement to launch the OMT, in September 2012. We said:

"It will also be virtually impossible for the ECB to impose effective conditionality on debtor countries, meaning that the ECB can only hope that a series of unpredictable political decisions in member states will go in its favour."

To inject such conditionality, the OMT was linked to the European Stability Mechanism - the eurozone's permanent bailout fund - which comes with strict conditions (or at least is supposed to). To tap the OMT, a country has to be on an ESM programme. But, in effect, this made the OMT - despite it being run by an independent central bank - hostage to parliamentary and electoral politics.

As we argued in our analysis on the German Constitutional Court ruling on the ESM - a few days after the OMT announcement in September last year:

"...the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto."

Well, enter the Italian elections (and Beppe). Discussing the election results, we told the Telegraph on Monday that:

“People have forgotten that the OMT cannot be triggered without a vote in the German Bundestag. This is going to be a huge problem, and we may be back to the political stand-off between the North and South of Europe,”

And in our flash analysis yesterday, looking at the Italian election results, we noted:

“A fragmented, anti-austerity Italian parliament could also make it far more difficult for the country to tap the ECB’s OMT. This is because it would need to access the European Stability Mechanism simultaneously, meaning a series of strict conditions – which Berlusconi and others could resist – and approval from several Northern Eurozone parliaments, including from the Bundestag.”

Other analysts are now waking up to this issue as well.

Then again, if it ever came to a point where Italy actually needed to tap the OMT, things might be so bad that politicians on both sides (probably during a panic-stricken weekend) could be scared into accepting whatever ESM-deal that could be struck.

But it all goes to show that in the eurozone, there's no escaping the politics.

Shocker in Italy: A comedian-cum-politician wins twice as many seats as the 'Brussels candidate'

So we now have a pretty good idea of the election results in Italy. And there are two victims: eurozone stability and Mario Monti.

The winner: comedian-cum-politician Beppe Grillo. 

We knew from earlier today that there would be a hung Senate, meaning massive challenges ahead in forming a functioning government.

But what about the Lower House - Camera dei Deputati? Well, counting is almost completed so these projections of how seats will be allocated (courtesy of Rai) will most likely be very close to the final results. Bersani's centre-left coalition managed to secure a majority. The gap between Bersani's centre-left coalition and Berlusconi's centre-right coalition is around 0.4%, so the huge difference in seats is due to Italy's electoral system (which gives the coalition or party with the most votes an automatic majority of almost 54%). 

But this is the shocker: Beppe Grillo's Five-Star Movement - the party that came out of nowhere and whose leader wants to hold a referendum on both euro membership and the restructuring of the country's debt - looks set to become the largest party in the lower house, and the second-largest one in the Senate. This is exceeding all expectations (though we warned you!).

Grillo is going to win 110 seats, more than double those of  Mario Monti - the outgoing technocrat PM who was the clear favourite in Berlin and Brussels. Monti will only have 46 MPs at his disposal.

The scale of this defeat was pretty obvious at the press conference that Monti gave earlier today, in which he said he was "very satisfied" with the election results but was visibly emotional.

In contrast, a relaxed but triumphant Grillo chucked about "having another hot tea and then going to bed" when interviewed by 'La Cosa' - the Five Star Movement's official radio/TV station.

That so many Italians voted for anti-austerity parties also bodes ill for the ability of the eurozone to press ahead with its cash-for-discipline recipe. We will provide a more detailed analysis once the final results are in. But for now at least, there's no doubt about who's having the last laugh...

N.B.: The breakdown above does not include the 12 MPs elected by Italians residing abroad and the MP elected in the Valle d'Aosta region, who are subject to different rules - a small caveat which does not change the bigger picture.

The French Court of Auditors publishes its annual report: Little good news for Hollande

The French Court of Auditors has published its annual report this morning. It is an absolutely massive document, but we have dug out a few interesting findings and recommendations - many of which do not exactly make for happy reading for French President François Hollande and his government:

• According to the Court, France's public deficit for 2012 will "in all likelihood be close" to the target of 4.5% of GDP. However, the report warns that "important uncertainties remain" over the final figure, which is only due to be disclosed at the end of March. Therefore, "a deficit higher than 4.5% of GDP cannot be ruled out."

• Unsurprisingly, the Court stresses that the government's growth forecast for 2013 (+0.8%) is much more optimistic than those made by the IMF, the European Commission and the OECD - which all agree on 0.3%. The 0.5% difference, estimates the Court, could mean 0.25% of GDP increase in the deficit by the end of 2013.

• Crucially, growth forecasts have an impact on revenue estimates as well - especially when it comes to tax and social security deductions (which the French call prélèvements obligatoires, compulsory deductions). The French government is betting on a 2.6% increase of this type of revenue for this year - again, far too optimistic. Tax and social security deductions, the Court explains, are closely linked to how much the economy grows, and have a significant level of 'elasticity' - meaning that they may well be lower than expected even if (and it's a big if by now) the French economy were actually to grow by 0.8% in 2013.

• The Court concludes that the structural deficit targets (which are relevant under the fiscal treaty and the so-called Excessive Deficit Procedure) are "attainable". However, the nominal deficit target of 3% of GDP for 2013 is "very weakened" by the slowing down of the economy. 

• On the recommendations side, the Court notes that the French government's deficit reduction effort has relied too much on tax hikes. Therefore, the Court argues, "Stepping up the efforts to rein in spending in the public administration as a whole is now the absolute priority. In fact, the structural [deficit reduction] effort for 2013 is unbalanced: it relies on public spending control for less than 25%, and over 75% on increases in mandatory deductions." 

Some fairly damning assessments then, and we have only scratched the surface of the report. This is also not the first time Hollande has faced this type of criticism from the Cour de comptes. The French Economy Ministry has responded to the report, saying the government sticks to its targets for 2012-13, but will "reappraise" its growth forecast in the new stability programme, due to be submitted to the French parliament in mid-April. Could this be the first step towards a public admission that France will miss its 2013 deficit target?           

Silvio's new(ish) electoral pledge: Renegotiate the fiscal treaty

Silvio Berlusconi yesterday stepped up his anti-austerity rhetoric another notch. During a quite heated exchange with Italian journalist Maurizio Belpietro on public broadcaster Rai Uno, Berlusconi made a new(ish) electoral pledge: renegotiate the European fiscal treaty.

Here is a translation of the most interesting bits (the full video, in Italian, is available here):

Belpietro: "There's a fiscal treaty which has been signed and ratified by Italy too..."

Berlusconi (interrupts): "No, no, no. We need to go and negotiate with the European Commission. And [we need to] negotiate without getting down on our knees before the European authorities."

[...]

Belpietro: "So would you overturn that agreement? Would you renegotiate it?"

Berlusconi: "Absolutely. Even at the cost of another vote [on the fiscal treaty] in the Italian parliament."  

Given Il Cavaliere's notorious obsession with 'the Communists', it is perhaps slightly ironic that he is now basically using the same arguments as the Socialist François Hollande during last year's French presidential campaign. As we stressed in previous blog posts, though, for the average Italian a promise to fight back EU-imposed austerity remains a powerful argument - and that is something which Berlusconi is well aware of.

EU awarded its second Nobel Prize of the year

Yesterday, a delegation headed by Bernadette Ségol, Secretary General of the European Trade Union Confederation (ETUC), delivered a 'Nobel Prize for Austerity' to the EU - a boomerang with 'Austerity will come back in your face' written on it, according to Italian news agency ANSA.

Unsurprisingly, Barroso, Van Rompuy and Schulz weren't exactly elbowing their way to the front of the queue to pick up the award, which was ultimately handed to EU Social Affairs Commissioner László Andor.

This was the only (relatively) light-hearted moment of a day which saw anti-austerity protests degenerate into violent clashes between demonstrators and the police in Italy, Spain and Portugal - while marches were also staged in several other European countries. Some Spaniards even rallied in Smith Square, London, in front of the European Commission and European Parliament's offices (see the picture, which was posted on Twitter yesterday evening).

We have stressed on several occasions that these protests are the inevitable consequence of the clash between eurozone membership and national democracy.

While structural reforms and fiscal consolidation are needed for struggling eurozone countries to try to regain competitiveness within the single currency, what the European Commission should be most concerned about is the fact that citizens in the weaker eurozone countries increasingly see the EU (and certain creditor member states) as the cause of their pain.

As we noted in a recent briefing, the average level of trust in the EU in Greece, Spain, Portugal, Ireland and Italy has reached an all-time low. Again, it is impossible to know where the tipping point lies exactly - but the recent episodes seem to confirm that the number of those who see the EU as a positive force is rapidly decreasing.        

EU budget talks are heating up (and Brussels isn't doing itself any favours)

EU budget talks are heating up, with member states still unable to agree on the size of the next long-term budget, to run between 2014 and 2020.

EU leaders will try to settle differences at a summit on 22 and 22 November. As things currently stand, a deal looks unlikely, with David Cameron in a particularly tricky position (for just how tricky, see here). Today we got a taste of things to come: the Brussels institutions launched a three-pronged attack on economic common sense.

• The European Parliament voted for 6.8% increase to the EU’s 2013 budget (which is subject to Qualified Majority Voting and co-decision between national ministers and MEPs), thereby rejecting member states’ compromise 2.79% increase, instead going with the Commission.  

• In a report, the EP also backed a 5% increase to the EU’s long-term budget (and a lot bigger increase if off-balance sheet items are included), in line with the European Commission’s original proposal. This proposal has been rejected by all net contributing member states (which doesn’t mean that the net contributors agree amongst themselves).

• Finally, the Commission said today that it needs to amend the 2012 EU budget, since there's not enough cash left. If you’re a government on an EU-mandated austerity programme - or a a household - you’re forced to prioritise and find savings when there’s not enough money in the pot. If you’re an EU institution you ask for an additional €9bn (with roughly €3.1bn from fines imposed on member states, meaning that national governments will have to put up €5.9bn in total).  

Cheers for that.

So if the EP/Commisison 2012 and 2013 proposals stand, which they probably won’t (we’ll return to the long-term budget), UK taxpayers would be forced to cough up another £2bn or so (£1.3bn increase for 2013 + £700m extra funds for this year), depending a bit on exchange rate used and the UK's pre-rebate share of the EU budget (both vary).

And those people who want the UK to leave the EU just got some additional killer campaign material to play with.

Well done Brussels.

What keeps the folks in Brussels and Berlin awake at night?

Possibly this graph - from our new report on the internal devaluation needed in the PIIGS for the euro to remain intact.

Source: Eurobarometer

It shows how trust in the EU amongst voters in the PIIGS has on average fallen from 55%  in 2001 to 25% in 2012, in the wake of EU-mandated cuts. On average, 66% of voters in these countries now mistrust the EU (up from 26% in 2001). And Spain still has half of its internal devaluation ahead of it (not to mention Greece). This won't be easy.

Initial thoughts on Spain's latest austerity budget

We’re still waiting for the full breakdown and figures behind the Spanish budget (which we will analyse and post in due course) but in the meantime here are our initial thoughts:

• The decision to tap the pension/social security reserve fund for €3bn was surprising. Generally this is a fairly last resort approach, but why Spain felt the need to do this to get its hands on only €3bn isn’t clear, especially with short term borrowing costs still low. Could Spain’s liquidity problems be greater than thought?
•  The interest Spain will have to pay on its debt will go up by €9.7bn, compared to a total package of cuts of €40bn (undoing almost a quarter of them). For a country the size of Spain even seemingly substantial cuts can easily be offset by the massive debt burden.
• The majority of the savings (58%) will come from spending cuts rather than tax increases – there is an on-going debate over which is more effective but in the short term spending cuts are likely to harm economic growth (especially given the reliance on the state as an economic driver in Spain).
• Tax revenue is expected to go up by 3.8% - given that growth is likely to falter this seems incredibly optimistic, even with some tax increases.
• The basic macroeconomic forecasts for the budget haven’t changed – this suggests that the overly optimistic growth forecasts are likely still in place, despite most investors and international agencies reducing their forecasts.
• Unemployment is predicted to have topped out this year – again this seems hopelessly optimistic given that structural labour market reforms are yet to take full effect (and there are still more to come) while internal devaluation will need to continue at a rapid pace (see our recent briefing here for more info on this).

So, plenty of issues already, with what seems to be a fairly unconvincing budget given the state of the Spanish economy. 

One final point to note is that Spanish Economy Minister Luis De Guindos kept insisting that the measures were all in line with recommendations from the EU/IMF/ECB troika or in some cases even went further. This looks to be leading into a Spanish reform programme as part of a bailout/bond buying scheme, hinting that Spain may be preparing that request after all.

A German euro exit 'not science fiction' for Il Cavaliere

The Huffington Post has decided to go for a lengthy interview with Italy's former Prime Minister Silvio Berlusconi for the launch of its Italian edition. Il Cavaliere sticks to his form on the euro, firing a salvo at Mario Monti (the Italian elections are drawing closer after all), arguing,

"I would have been less servile than Monti to Germany, a hegemonic state which is imposing the rule of rigour and austerity on other European countries - claiming that one can reduce [public] debt through austerity. But this is an illusion: public debt can be reduced by increasing GDP, which means development and growth."

Despite coming from a different political family, this sounds very similar to what France's Socialist President François Hollande said throughout his electoral campaign.

Berlusconi also seems to have revisited previous claims that leaving the euro "wouldn't be the end of the world" for Italy. He now says "it would be hard to exit the eurozone today", adding:

"There are three possibilities. The first one: convince Germany that we can't go on with austerity only. The second one: Germany leaves the eurozone, which is not science fiction given that German banks themselves have considered the possibility of replacing the euro with the D-mark. And the third one: other countries leave the euro, which would, however, mean the end of the single currency and scrapping Europe."

He says he favours the first option. 'Buona fortuna', Silvio.

Asked about his recent criticism of the fiscal treaty - which his party supported in the Italian parliament - Berlusconi claims,

"As the head of the [Italian] government, I fought a solitary battle over the fiscal treaty in Brussels, because France was perfectly aligned with Germany's pro-rigour stance. I even vetoed the inital draft blocking the discussion...In [the Italian] parliament, we voted in favour of the fiscal treaty for sense of responsibility." 

Interesting claim, as Berlusconi stepped down more than a month before the first draft of the fiscal treaty was tabled..  

In other news, Berlusconi is still refusing to officially confirm his comeback.

ECB's own budgetary discipline not inspiring confidence

With budgetary discipline the only game in town in the eurozone, it must have been a bit of an awkward moment at the ECB when they realised that the bank's new Frankfurt headquarters (pictured), currently under construction and due to be completed in 2014, will come in significantly over budget.

Executive board member Jörg Asmussen let the cat out of the bag in his welcome address at today's 'topping-out' ceremony, revealing in his welcome address that:

We are monitoring the construction progress, costs and price developments very closely, adjusting and adapting where necessary. As a public institution, we are committed to using our resources responsibly. This is essential. So far the ECB has spent approximately €530 million in construction and other costs, including the purchase of the site. In 2005 the overall investment cost was estimated at €850 million at 2005 constant prices. It is anticipated that increases in the price of construction materials and construction activities from 2005 until the completion of the project in 2014 will lead to a €200 million increase in the overall investment cost. 

In addition, there have been a number of unforeseen challenges that needed to be dealt with. The two major challenges unforeseen in 2005 were, first, that the original tender for a general contractor did not yield a satisfactory result and the ECB had to change to a different contractor model, and second, that the Grossmarkthalle – a large industrial heritage building from 1928 – presented a number of challenges that were not detected in the initial examination conducted prior to the acquisition:

• the foundations turned out to be insufficient and required additional support; 

• the roof coverage was found to be contaminated and therefore could not be disposed of as envisaged; 

• and parts of the concrete construction had insufficient steel support.

These factors are likely to account for additional costs of about €100-150 million, or a 10-14% increase in the overall investment cost. The resulting delay in the construction works on the Grossmarkthalle, as well as the entrance building, has been incorporated into the existing time schedule.

So overall the total cost is likely to come in at around €1.2bn, a tidy sum of money, even at a time of multi-billion euro bailout funds. We estimate that the cost of the new building amounts to around half of the outstanding cuts the Greek coalition still has to make in its latest austerity package.

DPA notes that the new building will hold 2,300 personnel, seemingly large enough for a central bank. Although when you consider that the ECB is currently looking to take over the supervision of 6000 financial institutions - a job which national supervisors currently employ tens of thousands of people to do - one does wonder whether another new building could be needed in the near future. 

We can't say the ECB is setting a great example for austerity, especially given that is now a precondition for accessing its new bond-buying programme.

Anti-austerity inside the eurozone: Greek voters stick to their potentially false choice

The key trend in Greek opinion polls holds steady: voters back anti-austerity parties in great numbers but  remain committed to staying in the euro in equally great numbers. The latest Public Issue poll released yesterday put the radical left Syriza as the largest party with 30% of the vote, New Democracy on 26% and Pasok on 15%. The figures suggest a surge in support for Syriza but also a move back towards the larger parties, with smaller parties falling in the polls.

Interestingly, a poll from Ipsos suggests that 70% of Greeks would vote to keep the euro if a referendum on the issue were held today, this compares to 50% of Italians, 62% of French, 51% of Germans and 55% of Spaniards. Interestingly, 38% of Italians would vote to leave the euro if a referendum was held today - that's quite high given the country's traditional support for the single currency.

On a less surprising note, from today's Die Welt we learn that fears over Greece leaving the euro has triggered yet more Greek tax evasion. Greek tax revenues between January and April were €500m lower than anticipated in the 2012 budget, while April’s takings fell by 13% on the previous year.

That is not a good sign.