France and Italy get preliminary approval of their budgets, but it's not the end of the story

The European Commission has given France and Italy a preliminary nod through on their draft budgets for 2015. In a statement released yesterday evening, Commission Vice-President Jyrki Katainen said:

"After taking into account all of the further information and improvements communicated to us in recent days, I cannot immediately identify cases of 'particularly serious non-compliance' which would oblige us to consider a negative opinion at this stage in the process."

An outright rejection of the French and Italian budget plans was always unlikely, as it was in no-one's interest to trigger an almighty row involving the second and third largest Eurozone economies. However, doing nothing was also never really an option for the Commission. Had it let France and Italy get away with draft budgets that were not only clearly deviating from their deficit reduction commitments but also not even acting to try and meet them, the credibility of EU fiscal rules - already wafer-thin - would have been shattered.

Over the past few days, both France and Italy pledged to make additional cuts to those initially planned for next year. Therefore, at least in terms of political narrative, the Commission got the upper hand in this first round. It stood up for budget consolidation, and it made its demand for extra efforts heard in Paris and Rome. On the other hand, for all their anti-austerity bluster, French President François Hollande and Italian Prime Minister Matteo Renzi are likely to come across as eventually bending to the will of Brussels.

That said, this is by no means the end of the story. The measures proposed by France and Italy to achieve the extra deficit reductions look far from structural. Also, as the FT notes, the changes are still short of what the Commission demanded and remain vaguely defined: 

• In his letter to Katainen, French Finance Minister Michel Sapin mentions the lower interest rates on French debt, the lower contribution to the EU budget recently announced by the Commission (we have written extensively on this issue, see here and here), and a strengthening of the fight against tax evasion.

• Similarly, his Italian counterpart Pier Carlo Padoan said he would use a €3.3 billion tesoretto (literally 'little treasure', but basically a reserve fund), originally set aside to lower the tax burden in 2015, to reduce deficit instead. However, there seems to be no guarantee that Italy will be able to find the same amount of money every year.

The Commission will issue its final verdict on the draft 2015 budgets of all Eurozone countries by the end of November. We would expect the Commission to come up with a set of stringent recommendations for France and Italy, although an entirely negative opinion looks unlikely. In the end, we may well see a replay of the current discussion. In the meantime, as the contrasting headlines from the New York Times today show, some may struggle to discern who exactly capitulated... 

The print version and online version of the New York Times today struggle to judge who blinked first...

Berlusconi: Let's breach EU deficit rules, no-one would throw us out

With the next meeting of EU leaders only one week away, Silvio Berlusconi has stepped his anti-austerity rhetoric up by a few notches. He said yesterday,

"We need someone from the [Italian] government to go to Brussels and tell those gentlemen, ‘We are in this situation because of your damn austerity policies. We must put things back in their place. From now on, you can forget about the fiscal pact and the deficit limit of 3% of GDP. Do you want to throw us out of the single currency? Go ahead. Do you want to throw us out of the EU? Well, we’d like to remind you that we pay €18bn a year [into the EU budget] and only get €10bn back’. Who would throw us out?"

As usual when Berlusconi is involved, these incendiary remarks form part of a broader communication strategy. Following his party's poor showing in the latest round of mayoral elections, Berlusconi wants to make clear to his electorate that he is still dictating the agenda to Italy's coalition government - and that he means business when it comes to keeping his flagship electoral promises, be it about scrapping a property tax on first homes or putting an end to EU-mandated austerity.

However, this time the explicit invite to ignore EU deficit rules is in clear contradiction with the line taken by Italian Prime Minister Enrico Letta so far: Italy does want an easing of austerity at the EU level, but will keep its deficit below 3% of GDP and respect all its commitments. Therefore, Berlusconi's words risk shaking the coalition government at home, and undermining Italy's credibility vis-à-vis its eurozone partners.

It will be extremely interesting to see if, once in Brussels next week, Mr Letta pretends his coalition partner Berlusconi never said those words or takes Il Cavaliere's advice on board and adopts a tougher anti-austerity stance with German Chancellor Angela Merkel and the other Northern eurozone leaders.  

Berlusconi wants to say 'basta' to EU diktats

Silvio Berlusconi's interviews never go unnoticed. Yesterday evening, he told Italian TV channel T9 that:

"We now have a strong government…also vis-à-vis Europe. We need this government to go to Brussels and say ‘I’ll do it this way’. We can no longer accept certain diktats. It’s for us to decide what needs to be done to put our economy back on its feet." 

Our regular readers know this is not the first time Berlusconi uses this type of rhetoric (see here and here for similar remarks). But his words have a much greater significance now. The electoral campaign is over, and Berlusconi's party holds a number of key ministerial posts in the new Italian government - on which he can pull the plug whenever he likes.

As we noted before, Berlusconi's blackmailing power could lead to Italy taking a tougher anti-austerity stance in Brussels - and this is exactly what Il Cavaliere is trying to achieve. Pressure is now on Italian Prime Minister Enrico Letta, who has so far been a lot milder in his demands for an easing of austerity and has consistently stressed that Italy will stick to its EU commitments.

Letta can't ignore Berlusconi's requests, or the survival of his 'grand coalition' will be at risk. But he will also have to make these requests sound acceptable to German Chancellor Angela Merkel - who faces a general election in three months' time. Not the easiest of tasks.

Merkel and Letta shadowbox on 'growth' vs 'austerity'

New Italian PM Enrico Letta paid his first official visit to Germany yesterday, only hours after delivering his inaugural address to the Italian parliament. Much has been made of his strong 'pro-European' yet 'anti austerity' stance - so how would this go down with Die Kanzlerin? Here are some quotes from yesterday's press conference:

On 'growth' versus 'austerity'

Letta: "We have done our bit [on budget consolidation]…Europe has to implement growth policies."

Merkel: "We have to free ourselves from this misconception that growth and budget consolidation are opposed. Solid public finances are a precondition for growth. And growth is not only the state giving money, but it's creating conditions for small and medium enterprises to feel at home, to be able to invest and open up jobs. And for that we need structural reforms, good schools and universities, investments in research."

On national responsibility vs 'European Solidarity'

Letta: "In the past five years of crisis we did not find sufficient solutions because there was not enough Europe. This is my objective - and also that of Germany, because both our countries have a federalist vocation... If we reached these objectives [banking union, a fiscal and economic union and a political union] we could solve our domestic problems much easier."

Merkel: "We want to ensure Europe emerges from this crisis stronger than it went into it. As part of that every country must do its part."

On meeting EU targets

Letta: "How and where we will find the resources is a domestic matter. I don’t owe explanations to anyone. I’m not here to justify domestic choices... We have no intention of telling German citizens what they have to do, and we know German citizens have no intention of telling us what we have to do.”

Merkel: "Every country must complete its own tasks... [Italy] has already made significant progress on this path."

Overall, the tone of the press conference and meeting was fairly amicable and concilliatory. That said, there are clearly a number of potential flashpoints. For all the pro-European rhetoric, for Letta 'more Europe' clearly involves more financial help for Italy, be it via a bank resolution fund or debt-pooling and not more EU scrutiny of national tax and spending decisions which is the German approach - note Merkel specifically referred to the fiscal treaty as an "element of consolidation" and the ESM as "an element of solidarity".

As we've pointed out previously, Italy still faces a number of challenges - finding a way of balancing the books without money from the planned property tax (the cancellation of which was demanded by Berlusconi) and also re-starting the structural reform agenda which stalled under Monti following a promising start. Failure to achieve progress on these fronts will inevitably trigger tension with Germany.

A sign of things to come could be this comment from (German-born) Josefa Idem, Italy's new minister for Sports and Equal Opportunities who told ZDF that she "understands that the people most directly affected by the crisis and who draw a direct link with the austerity measures bear an aversion towards Mrs. Merkel."

Aufstand im Bundestag: Who are Germany's most rebellious MPs?

On Thursday, the German Bundestag is expected to vote on the Cypriot bailout. The package is likely to be approved with a clear majority - the opposition SPD and Greens will mostly back it. In addition, the symbolically hugely important "chancellor's majority" - the threshold for the government to get an absolute majority with only the votes of its own MPs - is likely to be reached as well. Only around 12 MPs from the coalition parties (CDU, CSU, FDP) are likely to vote against. This is not particularly surprising. Remember, the bill for this rescue package was largely passed on to Cypriot depositors, and therefore enjoys much greater support in Germany.

Still, with the eurozone bailouts remaining ever-so contentious - and with a new anti-euro party on the German political scene - we thought we'd see how many coalition (CDU, CSU and FDP) MPs have so far rebelled on the various eurozone bailout votes. 

As the table below shows (click to enlarge), according to our calculations, at least 36 MPs have rebelled against Merkel on at least one occasion. Four MPs - Klaus-Pieter Willsch & Manfred Kolbe (CDU), Peter Gauweiler (CSU) and Frank Schäffler (FDP) - have a 100% record in rebelling on eurozone votes - for the rest, there's a surprising spread.

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.

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.

Yesterday's Karlsruhe ruling: Good news for Germany and Europe?

Following yesterday’s ruling by the German Constitutional Court in which it gave the go-ahead to both the ESM and fiscal treaty, German politicians from all the main parties were tripping over-themselves to praise the Court and its ruling. Speaking in the Bundestag, Chancellor Merkel declared it “a good day for Germany and a good day for Europe” while Foreign Minister Guido Westerwelle praised “the [Court’s] wise decision in the pro-European spirit of our Constitution.” The SPD’s parliamentary leader Frank-Walter Steinmeier also welcomed ruling, in particular the additional participation rights for the Bundestag.

While some politicians - including those who had themselves lodged legal challenges - said they were disappointed, even politicians who have been among the fiercest critics of the euro-zone bailouts declared their satisfaction, with, for example, the FDP’s Frank Schäffler describing the verdict as a “victory for democracy”, claiming that with the imposition of the cap on German liability, “The ESM has lost its sharpest tooth”.

However, interestingly the German media has adopted a more sceptical tone altogether. For example, today’s Süddeutsche comments that:

“In their ruling, the judges clearly called out the risks of the euro-rescue but drew few consequences. Their reservations do not change the fact that Europe is moving together under great financial and political risks.” 

In a front page op-ed, Die Welt editor Thomas Schmidt draws in the ECB OMT bond-buying angle – something that we also cover in our analysis of the ruling - arguing that:

“The Court watches over German money and the issue of democratic legitimacy. It is clear that the ECB decision has opened the way into the bottomless transfer union in principle. It is equally clear that the legitimacy of the path towards the further deepening of European integration is poorly grounded. This must and will result in yet more legal challenges.” 

FAZ's economics editor Joachim Jahn describes the verdict as “a slap in the face of financial policymakers”, but warns that:

"With the requirement to secure a liability cap binding under international law, the judges have at least curbed the potential harm to the taxpayer… It is however questionable how much exactly the Karlsruhe order would be worth in an emergency. A protocol to the effect that Germany does not feel itself bound by alternative interpretations of the agreement is would be easy to obtain. Whether this would be considered material by the ECJ in the event Italy and Germany were to argue over reserve liabilities is by no means certain."

Last but not least to Bild Zeitung, whose chief editor Nikolas Blome argues that:

“The ECB’s [OMT] programme is perhaps well intended but not well executed. It is highly dangerous – and here the Court’s ruling changes nothing. The double whammy of the ESM and ECB is essentially so strong so as to be able to save every eurozone member. However, exactly this will lead all eurozone states into temptation: why enact painful reforms and brutal savings when it could be supposedly easier at the expense of the others, and Germany in particular?” 

The relief of Germany’s politicians is palpable, but the battle for the future of the euro – and the role of the ECB in particular – is still far from over.

A new EU treaty, a December summit… Déjà vu anyone?

A key question for the future institutional arrangement of the Eurozone is whether further integration will happen at the level of all 27 member states, within the framework of the EU treaties, or whether the Eurozone will simply press ahead with an ‘inter-governmental’ deal, circumventing the acquis communautaire and non-eurozone members.

This is critical for the UK as under the latter option, Britain will have little to no leverage over future Eurozone integration, whereas under the former it’ll have a solid veto, which it can use to extract all kinds of concessions in pursuit of its national interest. Following Cameron’s veto to an EU-27 treaty change last December – which resulted in the intergovernmental fiscal treaty - a host of eurosceptics and status-quo defenders alike now tend to argue that the precedence has been set; Eurozone members can do whatever they want inter-governmentally, they say, and use the EU institutions at that. Britain has been reduced to the role of a spectator. The plot has been lost and the goose has been cooked.

From there, some eurosceptics reach the conclusion that Britain should withdraw altogether, whereas the status quo defenders say Britain should hop on the train towards more integration (at which point they cease to be status quo defenders and turn into brave souls advocating that Britain signs up to a euro superstate).

So has the goose been cooked?

Well, this week’s Spiegel magazine splashed with the news that the German governmet is pushing for a new EU treaty that will consolidate and expand Eurozone budget oversight powers – referred to in Germany under the euphemism of ‘political union’ - under a firm legal framework. Chancellor Angela Merkel is reportedly pushing for a convention – comprising representatives from national governments and parliaments, the European Parliament and the European Commission – to be formed by the end of the year, with a first meeting to be agreed at an EU summit in December. If the article is accurate, a ‘convention’ would be about a ‘full’ Treaty change, not the limited one agreed in December 2010.

One of the main changes sought is the provision for the ECJ to rule if national budgets comply with the EU's fiscal rules, with the option of credible sanctions for non-compliance, something Merkel failed to secure in the inter-governmental fiscal treaty last year – courtesy of French nervousness over loss of souveraineté.

It’s difficult to gauge how credible the story is – speaking on ARD Merkel said that “I am not calling for a convention… that’s not the point”. Though politicians’ denials count for zero these days, it’s probably right that December is not realistic as a start date for a new EU treaty. Apart from everything else that needs to be sorted first, EU leaders still remember how long it took to push through the European constitution/Lisbon treaty – which Europe’s citizens didn’t like that much (as for being a ‘crisis’ this was of course a mere prelude to what has come to pass since). And unlike the Lisbon treaty, codified central fiscal controls would be about decisions over taxation and spending – the bread and butter of national politics. Also, non-euro member states – such as Poland - oppose a new treaty at this time on the basis that it would widen the euro/non-euro divide with a negative impact on the single market.

But while it is clear that there is no great enthusiasm for it, it is difficult to escape the conclusion that at some point in the near future, the eurozone will need a new set of rules if it is to stay together in the longer term. As good as the EU is at fudging it, ploughing on incrementally with economic and fiscal integration is politically unsustainable. So the question for Britain’s leverage in Europe really becomes, how bad does the Germans want to anchor Ordnungspolitik in EU law. Well, as we argued in the Telegraph back in February:

 “The Germans in particular – ever conscious of their Constitutional Court– know that the current arrangement involving an ad hoc euro treaty is legally dubious. As long as the Germans feel uncomfortable, Cameron maintains his leverage.” 

This is key. For a range of reasons (see here, here and here), the Germans don’t have that much confidence in Eurozone inter-governmental arrangements, as it leaves them more at the mercy of the ‘Club Med’ and creates a grey zone between EU law and the German ‘basic law’ which is just too awkward to bear for many Germans. Sooner or later, there will be an attempt at EU treaty changes.

Does the UK know what it wants?

The Karlsruhe factor, Part IV

Throughout the eurozone crisis, we have often highlighted the gap between the kind of ‘shock and awe’ decisions expected by financial markets, and what national democracies are able to deliver. Nowhere has this been more evident than in the on-going constitutional tug-of-war between the German government and the country’s Constitutional Court (see here, here and here for background). The latest chapter concerns a series of legal challenges against the ESM and fiscal treaty, on the basis that they violate the sovereign budgetary rights of the German Parliament.

The stakes are very high given that the Court could, in theory, strike down the best part of Merkel and Schäuble’s efforts over the past year. It is unlikely that the Court will do so given the ramifications, but at Tuesday’s public hearing, the judges (pictured in their traditional red robes) indicated that they would take their time before issuing a ruling; up to three months to decide on whether to issue a temporary injunction pending a full decision on constitutional compatibility early next year.

This delay is most unwelcome news for Merkel who is desperate to reassure financial markets and other political leaders that Germany is serious about the eurozone rescue, which is why she expended a lot of political capital in pushing the two treaties as a package measure through the German parliament in record quick time, and was angry that after all that German President Joachim Gauck refused to give his assent after the Court asked him to allow them time to consider their legality.

The problem is that the Court was specifically designed – by the British and the Americans no less - to counteract the concentration of power and rash decision making by other federal institutions, a sort of systemic circuit breaker. It is for this reason it is tucked away in sleepy Karlsruhe, the opposite end of the country to Berlin and previously Bonn.

The question of urgency vs caution has led to deep divisions not only within the German government but also the wider political and constitutional establishment. Ahead of the proceedings, Justice Minister Sabine Leutheusser-Schnarrenberger (FDP) said that:

“Government and politicians should stay out of this completely. The Constitutional Court does not need any advice... Judges are also aware of the importance that their decision will have on the economy.”

However, addressing the Court directly, Finance Minister Wolfgang Schäuble warned that:

“A considerable postponement of the ESM… could cause considerable further uncertainty on markets beyond Germany and a substantial loss of trust in the eurozone's ability to make necessary decisions in an appropriate timeframe”.

Meanwhile the Guardian reports that Chancellor Angela Merkel allegedly told a private meeting of her CDU party that the Court was “pushing the limits” of her patience, while Martin Schulz, the President of the European Parliament complained that some of the Court’s verdicts are "characterized by great ignorance”. Conversely, Bundesbank President Jens Wiedmann, also giving evidence, warned that “a quick ratification is no guarantee that the crisis will not escalate further".

The graphic below shows how Germany’s major political figures have found themselves at odds over the Court ruling, with figures from all parties adopting a range of positions on the issue:

The German media on the other hand have presented a broadly united front, with Die Welt noting that the Court’s eventual ruling will determine “How far European integration can go without damaging the democratic substance of Germany”. A leader in German tabloid Bild argues that “It is totally right that the constitutional judges take more time – after all, the question is whether Germany is overburdening itself financially. That would be a lot worse than short term turbulences on the financial markets”, while in centre-left broadsheet Süddeutsche Zeitung, Heribert Prantl argues that:

“Karlsruhe has to find the ways and means by which Europe can continue to be built without breaking the foundations of the constitutional settlement. The success of this search is existentially vital for Germany and the EU. It is more important than the fleeting applause of the so-called markets in return for a quick decision.”

While the Court, even in the opinion of some of the litigants, is not expected to torpedo the eurozone rescue at this stage (although they take a slightly more pessimistic view over on FT Alphaville), the red lines of the existing constitutional settlement are looming ahead, with most forms of debt pooling that many have called for - such as Eurobonds or a banking union - lying on the opposite side. As the debate over the future of the eurozone will continue to rumble on, expect further tension in the broadly consensual model of German politics between further European integration on one hand and preserving the current constitutional settlement on the other.

What will proposals for a fiscal and banking union mean for the Eurozone and the UK?

Ahead of this week’s EU summit, Open Europe has published a briefing note summarising the various ideas floated for a fiscal and banking union in the wake of the eurozone crisis, analysing their potential impact on the UK and the eurozone. Given the embryonic nature of many of the ideas, Open Europe concludes that none constitutes a realistic short-term, or even medium-term, solution to the crisis. In particular, Germany’s insistence on an effective veto over other member states’ spending over a certain level as a precondition for fiscal burden sharing is itself a huge political obstacle that may not be overcome anytime soon.

The briefing also notes that it’s virtually impossible to separate a fiscal union from a banking union, as they are interdependent. Open Europe estimates that, taken together, an EU bank resolution fund and deposit guarantee scheme will need to be worth at least €600bn to be credible, with a direct credit line to either ECB or national treasuries. However, in a crisis situation, this amount could be far higher. Since 2008, for example, the EU has approved €4.5 trillion in national state aid to financial institutions in Europe – an EU banking resolution fund must be prepared to inject similar amounts. This fund could initially be built upon the existing ESM framework, although it would require a substantial rewriting of the ESM treaty and a large increase in its lending capacity.

We’d note that a banking union in the eurozone does come with merits, but it is effectively a fiscal union via the backdoor given that eurozone governments will ultimately have to jointly stand behind all the banks in currency union. Therefore, there is a very real risk of banks in one country free-riding off the backs of taxpayers in another is therefore huge and the Germans are absolutely right in insisting on fiscal safeguards to avoid this happening. But this is also why banking union, even in an optimistic scenario, is years away.

For better or worse, a banking union will inevitably have an impact on the UK’s place in Europe and add pressure on the Coalition to seek safeguards ensuring that a more integrated Eurozone is compatible with the UK’s economic and political interests. A key question for the UK is whether it really wants the ECB tasked with supervising a banking union in which cannot take part itself, and how to avoid barriers to financial trade in the Eurozone for UK firms if this happens.

For the full report see here.

Does the SPD really support eurobonds?

Update 1.45: It looks like Trittin has performed one of the fastest and sharpest u-turns of recent times, as he is quoted by Reuters earlier today as saying: "Merkel should stop blocking eurobonds" and suggested it could be a condition for his party's support for the fiscal treaty. This is also a matter of semantics though, as the Greens remain in favour of a limited form of fiscal burden sharing or debt mutualisation. It still illustrates the wider point however: eurobonds are in for a rough ride in Germany.

Update 1.15pm: Die Welt has published a more detailed follow-up on the issue and the Green party has followed the stance of its oft senior coalition partner and also rejected eurobonds at the present time. Green parliamentary co-chairman Jürgen Trittin said that while he agreed with the economic principles behind them, they were the wrong solution at this time, not least because it would require changing the EU Treaties. The paper states that both parties prefer an alternative, only partial, pooling of eurzone debt, possibly via a debt redemption fund.

Original post:

There's a school of thought out there - usually fairly uninformed - which has it that a German government that features the SPD (social democrats), could fairly effortlessly strike a deal with Francois Hollande over further fiscal integration, which would include, for example, eurobonds and greater ECB intervention. People arguing this point notes that SPD supports eurobonds, while doing fairly well in opinion polls. That should cut it right?

Well, this view tends to underestimate the German cross-border consensus on sound money and budget discipline. And from today's Die Welt we learn that the SPD has retreated from its previous support for Eurobonds, thereby distancing themselves from their French counterparts. Thomas Oppermann, the party’s speaker in the Bundestag said:

"We oppose the uncontrolled pooling of debt… There is absolutely no need for general eurobonds". 

Oppermann added that:

“I speak for [Germany] and not for France”.

And there you have it from the horse's mouth...this will be a long, unpredictable debate in Germany.

What do a British Conservative PM and a French Socialist President have in common?

Over on the Telegraph blog, we note:

David Cameron will have his first face-to-face meeting with newly elected French President Francois Hollande today, at a G8 summit in the US. There has been some fuss about Cameron and Hollande not getting along. Cameron snubbed Hollande during a visit to London. And, most importantly, one is a French Socialist, the other a British Conservative. They must be each other’s diametrical opposite, surely?
Well, judging from some of their remarks and actions over the last year, if one didn’t know any better one would think they actually have quite a bit in common:

Both are trying to cut deficits: Yes, despite all the anti-austerity rhetoric, Hollande is trying cut spending too (as we’ve noted, the difference between the economic plans of Hollande and the ousted Sarkozy was paper thin). As his new economy minister Pierre Moscovici put it, “Hollande has always said that we should tackle state debt and reduce deficits”. Hollande wants to achieve a ‘balanced budget’ by 2017, Cameron wants to eliminate the UK’s spending deficit by 2015, albeit both are likely to fail.

Both have threatened to veto an EU treaty: In December, Cameron vetoed an EU Treaty change to impose greater fiscal discipline in the Eurozone. Equally, Hollande has implicitly threatened to veto the free standing ‘fiscal treaty’ (itself a result of Cameron’s veto), unless a clause on various fiscal stimulus measures is added. The rationale in each case is of course different but both have clashed with Germany’s view of the solution to the crisis.

Both have called for the ECB to become the euro’s lender of last resort: Causing half the German population to choke on their morning pretzels, Cameron and Hollande have both called on the ECB to do far more to “share the burden” of the Eurozone crisis through monetary activism, which probably means the ECB buying hundreds of billions of government bonds (which Cameron has endorsed implicitly, Hollande explicitly).

Both have toyed with the idea of eurobonds: In the past, both have called for a discussion on the eurozone moving to full debt pooling via eurobonds. Cameron called for it again yesterday, while Hollande hasn’t mentioned the idea since August last year and seems to have backtracked somewhat (his ‘project bonds’ are something different).

Both leaders have cabinets with ministers who opposed the flagship Lisbon Treaty/European Constitution: Laurent Fabius, new Foreign Minister, campaigned successfully for a “no” vote to the European Constitution in in 2005, while his UK counterpart William Hague, and most of Cameron’s cabinet (Ken Clarke excepted) opposed both the European Constitution and its successor the Lisbon Treaty.

So what’s my point? Of course, there are a whole range of disagreements between the two leaders. But two observations: first, the ‘austerity vs. growth’ debate is fundamentally false – even the proclaimed anti-austerity champion realises that public spending needs to be cut (at least in theory), while everyone is in favour of ‘growth’. The debate is on how to get there. Secondly, the line between the alleged ‘Eurosceptic’ and the alleged ‘pro-European’ suddenly becomes awfully blurred (who’s who again?) as both, obviously to different degrees, have problems with the status quo in the EU/Eurozone.

Bends assumptions doesn’t it?

Europe awaits the next French President

Sunday will be a big day in EU politics: both the Greeks and the French go to the polls.

Ahead of the French elections, we've published a briefing looking at the possible impact of the election results on Europe. In particular, we note that,

"No matter who wins, France could well become a more difficult and assertive EU partner, though both candidates are likely to struggle to deliver on their various promises to take on Europe, such as re-negotiating the fiscal treaty and tougher border controls. The Franco-German axis will continue, but a Hollande victory in particular will mean a more unpredictable relationship and therefore potentially more uncertainty on the markets. Clearly, under Hollande, Germany will find it far more difficult to push its vision of a eurozone based on strong budget discipline.”

Do check out the full briefing here, and a brief summary here.

Apart from the obvious impact on the Franco-German axis, another thing is worth flagging up. Have a look at the graph below.

The graph illustrates that, beyond the rhetoric, the budget plans of the two candidates do not differ radically with respect to the impact on France’s debt reduction and budget outlook. The graph looks at how much the two candidates’ plans are meant to reduce French debt by – compared to the IMF projections and an adverse scenario estimated by Open Europe. Virtually, the only difference between the two is Hollande’s decision to delay a balanced budget by one year, and his more optimistic growth assumptions. It is not clear why Hollande’s growth expectations are more optimistic, given that the only difference is a slight delay in austerity – something which in turn casts serious doubt as to whether Hollande can actually deliver what he has promised. The IMF predictions highlight that both plans may be slightly optimistic but not impossible. Despite concerns over Hollande’s economic policy and its impact on the euro, if he manages to achieve roughly the debt reduction he sets out in his plan, it would clearly be a positive thing for both France and the euro.

However, as the adverse scenario highlights, any slippages (particularly with regard to the primary surplus) could bring France’s debt sustainability into question and also lead French borrowing cost to increase markedly. This would in turn shake confidence in the entire eurozone – not least since any French downgrade will also effectively reduce the lending capacity of the eurozone’s bailout funds (the EFSF and the ESM). Such slippages could be caused and/or exacerbated by any another crisis in Spain, to which France would be heavily exposed...

How real is Hollande's veto threat?

As has been widely reported, Francois Hollande - the socialist contender for the French Presidency - gave a major speech yesterday. Unsurprisingly, there were a few points thrown in that won't go down particularly well in Berlin or Frankfurt. Perhaps most interestingly, in reply to a journalist’s question on the EU fiscal treaty, Hollande answered,

“Ireland is about to have a referendum on the treaty, we are not sure what the result will be. We are all aware that Ireland is capable of saying no. So there will be some form of renegotiation. Will the treaty be modified? I hope so. Will another treaty be drafted? That’s part of negotiation. But the treaty in its current state will not be ratified by France”.

 So Hollande's veto-threat still stands. He also reiterated,

"[I am] not in favour of a constitutional golden rule. I’ve been saying it for months. So there will not be any changes to the French Constitution on this issue. However, if I am the next President, and the Parliament is in favour of this, there will be an organic law which will enable our budget to be rebalanced by 2017." 

In addition he tried to claim that the calls from ECB President Mario Draghi for a "growth pact" were in support of his own policy:

“The President of the ECB …has just said that the fiscal compact should be complemented by a growth pact. He even added that it would be useful to go back and prioritise education, research and big infrastructure. The ECB president will be useful to support growth through an interest rate policy. But he also adds support to… my announcement”

This is hardly how the matter was viewed in Berlin, where, in a veiled criticism of Hollande, Merkel said that "We need growth in the form of sustainable initiatives, not simply economic stimulus programmes that just increase government debt." This morning, Hollande also acknowledged on France Info that he didn't share the same "conception of growth" as Draghi, noting, "he calls for greater competitiveness, liberalisation and privatisation".

Yesterday, Hollande also laid out the content of his growth clause:

“The day after the second round, I will address a memorandum to all the European leaders and their governments on the renegotiation of the treaty. The letter will include four points. First, the creation of Eurobonds, not to mutualise debt, but to finance industrial infrastructure projects the size of which will be determined by the states. The second point will be to further liberalise the European Investment Bank’s financing opportunities, to enable a certain number of big projects already known to the bank to be financed. The third point will be the creation of a financial transactions tax, which will be determined by the states, and which will be set at a level to enable Europe to finance further development projects. Finally the fourth point will be to mobilise all the European structure fund leftovers, which are currently not being used, to finance States’ projects and help businesses." 

Of these four points, the creation of "eurobonds", which seems to build on the Commission's idea of 'project bonds' is by far the most interesting. The FTT proposal appears to be a rehash of Sarkozy's idea. It currently remains unclear whether Hollande would introduce it unilaterally, as Sarkozy is, when he encounters inevitable opposition from some EU member states. Nor is it clear at what rate he would set the tax, and which sectors he would target. Sarkozy's own version has been watered down since he made his pledge in December. Hollande's proposal for the use of unspent structural funds is hardly groundbreaking or exciting policy making. Nor does it necessarily help EU growth, as we have shown before.

The question now is whether Hollande will make agreement on these four policies a prerequisite for French ratification of the fiscal treaty. Of these four policies, eurobonds or 'project bonds' are supported by the Commission but could be difficult to get through national capitals, the FTT just won't happen at the EU-level while the two others are insufficiently interesting to warrant the renegotiation of a treaty (use of structural funds and EIB financing).  Our guess is that Hollande knows that his pledge to renegotiate the treaty comes at too great a political cost, and that he will settle for some mild language on these four areas in return for ratifying it.

Regardless, what France and Europe need now is to reassure the markets, and proceed with long-term reforms, rather than stillborn policies or palliatives to pre-existing problems.

What next for the Netherlands?

The political situation in the Netherlands continues to look uncertain, following the fall of the Dutch government, largely due to EU-imposed austerity targets.

Yesterday the Dutch Parliament debated the crisis (which we live-tweeted) with at times heated exchanges. So what has come out of it and where are we at?

• Outgoing PM Mark Rutte announced that he would propose 12 September as the election date, despite many parties calling for a June election to allow the new government to get on with business. 

• There is still disagreement over an absolutely vital issue: how to deal with EU austerity rules. The Dutch government has to present its 2013 budget to the Commission before 30 April, which needs to comply with the EU's 3% deficit limit or, says Rutte, the Netherlands could face a fine of up to €1.2bn (though it would take a lot for that to actually come to pass).

• Diederik Samsom, the leader of the social democrat PVDA, remains opposed to sticking to the the 3% rules, saying that going beyond that limit (his proposal is 3.6%) is allowed in "exceptional circumstances" - which was immediately denied by PM Rutte.

To put the Dutch economic problems into context, we are talking about a country with a deficit of 4.7% and debt to GDP of 65% (2011 figures), although high household debt and falling house prices are creating some trouble right now. Many countries would love to have this problem (the UK, for one). The problem, of course, is that these figures do not conform to the eurozone orthodoxy of austerity - of which the Dutch have been major cheerleaders, and in many ways the Dutch have made a rod for their own backs here.

In any case, talks are ongoing and a new debate is scheduled for Thursday. Our bet is on the political parties reaching an agreement to send to Brussels before the deadline and that will serve to appease the Commission.

But this runs far deeper than whether the Dutch can pass this year's budget, it raises fundamental questions about whether the country will be able to prodcue stable government in the longer term. Political fragmentation in the Netherlands has been a feature of the last decade. In 2003 the three 'mainstream parties' (PvdA, CDA, VVD) held 114 (76%) of the 150 seats in parliament. In 2010, this was down to 82 (54%). In 2012, who knows?

The one to watch is clearly Geert Wilders and his populist PVV party - if they gain, passing the EU fiscal treaty will be far more difficult in the Netherlands, as will eurozone politics in general. However, interestingly, Wilders is currently polling at the lowest level in two years, at 12.6%. What's also interesting is that the left-wing Socialist Party (SP), which has also been quite critical of the EU in the past, is polling close to 20% (governing VVD at 22% and centre-left PVDA at 16%).

But as we've noted before, the Dutch crisis is an indication of how unsustainable the current eurozone path is, and the tension involved in having key decisions on spending and taxation subject to supranational rules rather than votes in national parliaments.

Yesterday, Bild presented a list of eurozone countries where governments have already collapsed over the euro: the Netherlands, Ireland, Portugal, Italy, Greece, Spain, Slovakia and Slovenia.

The eurozone crisis used to be perceived as the the core versus the indebted periphery. What happened this week in the Netherlands has bent these assumptions.  But the common theme is that voters feel powerless to change the status quo. Whichever mainstream party they vote for, the answer is the same. For as long as this persists, no one should be surprised by the alternatives that people might seek.

Opening Pandora's Box?

Speaking to the press after the meeting of EU leaders earlier this month, Spanish Prime Minister Mariano Rajoy (see picture) surprised everyone by declaring that Spain had taken the "sovereign decision" to ignore the deficit reduction target of 4.4% of GDP agreed with the European Commission for this year.

As we pointed out here (and as Simon Nixon pointed out in the WSJ yesterday), the Commission had two options to cope with this situation: hardball or flexibility. And it has gone for the latter, although still asking Spain to bring its deficit down to 5.3% of GDP by the end of the year - that is, 0.5% lower than the 5.8% announced by Rajoy. This translates into an extra €5 billion of savings by the end of the year, something which Rajoy says Spain reasonably can achieve.

Leaving the bailouts aside for a second, Spain's behaviour may well be a hint at the true meaning of "economic governance" in the eurozone - constant bickering about who actually is in charge, the 'sovereign' member state or the European Commission (or some other vehicle of the Eurogroup).

In any case, the compromise 'deal' between the Spanish government and EU finance ministers gives rise to a number of questions:

Is this a victory for the Spanish government? Not at all. Despite Rajoy's efforts to sell it as such at home. Spain has only obtained a revision of its deficit target for 2012, but is still expected to cut its deficit to 3% of GDP by the end of 2013. In other words, the Spanish government is only kicking the can down the road and will have to make much tougher budget cuts next year in return for dodging them this year.

Is this a victory for the European Commission? Not really. At the end of the day, the Commission has allowed Spain to run a higher-than-agreed deficit for 2012. Needless to say, this did not go unnoticed. Explicit criticism has already come from Belgium and Austria, with the latter accusing the Commission of using "double standards" as Hungary - at the same meeting of finance ministers - saw almost half-a-billion euros of subsidies frozen for failing to comply with EU deficit rules.

Furthermore, Dutch Labour MPs have threatened to block the ratification of the new 'fiscal treaty' on budgetary discipline unless the Netherlands - like Spain - is allowed more time to put its own house in order. Dutch Prime Minister Mark Rutte’s coalition government needs the support of the opposition to pass the 'fiscal treaty' in parliament, as Geert Wilders’ far-right PVV party will vote against it.

The pact would still come into force if the Netherlands failed to ratify it - twelve eurozone ratifications would be sufficient. However, Triple-A countries are a rare breed in the euro area these days, and if one of them were to stay out, the 'fiscal treaty' would lose even more of its credibility. Uncertainty remains, but the Commission might really have opened a Pandora's box by revising Spain's deficit target for this year.

But are these targets even achievable? Almost certainly not. Spain's economy is expected to contract by 1% this year. Furthermore, the Spanish government has 'only' adopted a first package of around €15 billion in spending cuts and tax hikes, meaning that savings worth some €20 billion are necessary to meet the revised target for this year. Both of these facts are likely to increase the already sky-high unemployment rate. It's too early to tell whether the Spanish population is willing to stomach this. A new general strike against the Spanish government's labour market reform has been scheduled for 29 March - it won't be the last one.

The deficit target of 3% of GDP for 2013 looks even more out of reach - especially if this year's target is missed. As Rajoy told MPs yesterday, Spanish regions must be prepared to make "bigger" cuts, but some important Spanish regions (including Andalucía, where Rajoy's Partido Popular could win a majority after the 25 March elections, and wealthy Catalonia) do not seem particularly keen on taking more austerity. This is complicated by a feeling that the cuts are being 'imposed' by the central government. If the Spanish government fails to keep the regions on board, the chances of meeting the budget commitments look very slim indeed.

What's clear is that Spain will become a major testing ground for the effectiveness or otherwise of the eurozone's new economic governance structure.

The Fiscal compact in action....?

The eurozone chokes Spain....the fiscal compact in action?

An unfortunate picture has been doing the rounds this morning of Jean-Claude Juncker (Head of the Eurogroup of eurozone finance ministers) jokingly throttling the Spanish Finance Minister Luis de Guindos (don't worry they were all hugs after).

Nevertheless, this as an apt metaphor for the potential which the new fiscal compact has to choke economies such as Spain, with strict budget targets and massive austerity.

(More captions welcome in comments)

Will Merkel's fiscal treaty become a hostage of the FTT?

As we reported in yesterday's press summary, given that the recently signed 'fiscal treaty' will impact on the budgetary autonomy of the Bundestag, it will have to be ratified in both houses of the German Parliament by a two-thirds majority.

Here are some basic Bundestag mathematics: out of a total of 622 MPs, Merkel's coalition has 331 (195 from CDU + 43 from CSU + 93 from the FDP), far from the 415 MPs necessary for the two-thirds majority. So Merkel will definitely need to have some of the SPD's 146 MPs on side, and would also like to be able to count on the Greens' 68 MPs just in case. The remaining opposition party, Die Linke rejects the very premise of the treaty so all its 76 MPs are highly likely to vote against.

However, the SPD and Greens have already said their consent is conditional on a number of concessions from Merkel, most notably: a 'growth programme' to balance out the budgetary discipline element of the treaty and the introduction of a financial transaction tax (FTT - its not clear if they want it in just the eurozone or the EU as a whole, although the latter looks impossible). The SPD’s leader, Sigmar Gabriel told German radio that:

"Whether we vote in favour or not depends on whether Mrs. Merkel makes substantial offers to improve the fiscal pact. I can only urge Merkel to finally take care to ensure that her government ceases to oppose the taxation of financial markets.”

This has not gone down with the FDP, who have long been opposed to a FTT unless imposed across the whole EU as minimum. The party’s General-secretary Patrick Döring described the prospect of tying the ratification of the treaty to the introduction of an FTT as “inconceivable” and “irresponsible”, while parliamentary faction leader Rainer Brüderle criticised Gabriel, arguing that:

"This is no place for ideological battles for the purpose of winning future elections. The situation demands statesman-like responsibility from all concerned."

As things stand there is a classic stand-off over the issue, with significant risks for all parties concerned:

Giving in to demands for a FTT or weakening the budgetary discipline in the treaty further, would undermine Merkel's support within her own party and threatens to split the coalition - which could trigger early elections. That said, the threat of early elections may be just enough to keep the FDP in check given their dismal recent poll results. It would also cause huge problems for Merkel in Europe given that she has expended so much political capital on pushing this treaty through.

The SPD and the Greens are far from cohesive on all issues either and getting embroiled in a full debate on this issue could expose flaws in this fledgling partnership. Furthermore, the German public seem to be losing patience with politicians inability to tackle the eurozone crisis - further posturing on the issue for political gain could easily backfire.

In the end then consideration of these risks and the trend for orderly consensual politics in Germany means that the approval of treaty still looks highly likely, posturing aside. Nonetheless it looks as if Merkel will have to offer the opposition some concessions (e.g. the FDP have indicated they could stomach a watered-down FTT along the lines of the UK’s stamp duty). The extent of these could have a big impact on the power base of the current government and the outcome of the next election.

The vote itself is not scheduled until the 25th May, so there is 'plenty' of time for the party leaderships to hammer out a deal between themselves and present it to their MPs to be rubber-stamped...

Germany is gearing up for a major debate on the future of Europe, so must Britain

A few weeks ago Lord Owen, the former Foreign Minister, gave a speech, reworked for the Spectator here, in which he very eloquently set out the future challenges for Britain in an EU that is rapidly changing as a result of the euro crisis.

Owen noted that:

On 7 February 2012 the German Chancellor Angela Merkel indicated very clearly her direction of travel. The eurozone crisis for her is to be the springboard to another Treaty to replace the Lisbon Treaty. She said ‘Step-by-step, European politics is merging with domestic politics.’ She called for ‘comprehensive structural reform’ of the EU with closer integration to overcome what she called ‘major shortcomings’.

She had some months earlier, barely recognised in the UK, signed up to campaigning with fellow Christian Democrats across Europe for direct elections for the posts of President of the Commission and much more surprisingly and far-reachingly for the President of the European Council.

All this might seem some way off, but in an interview with Welt am Sonntag at the weekend, German Foreign Minister Guido Westerwelle repeated that it was “important to open the next chapter of European integration”. He argued,

“I regret that it has not been possible to adopt a truly European Constitution. We’ve noted that the Lisbon Treaty has design flaws. Many decision-making mechanisms are too complicated, and there is still a lack of transparency and clarity. Europe needs a common constitution, which the citizens should decide over in a referendum.”

Westerwelle also argued in favour of a directly elected European President, and a bicameral parliamentary system, with the European Council, where EU leaders meet, becoming an upper chamber alongside the European Parliament.

What does this mean for the UK?

Well, this debate about 'political union' is likely be the next stage of the plan to salvage the euro, after the debates over the fiscal treaty have ended. Whether it can ever work is the glaring question, especially if Westerwelle is good to his word about putting it to a referendum, but, clearly, significant elements of the German political machine are thinking that this is what Europe will need to discuss in the long-term.

Here are some more of Lord Owen's thoughts:

How should Britain react? We should firstly not react! This is our EU by Treaty; it can only be changed by unanimity and we must have a credible but different design and the determination to stay at the negotiating table until there is unanimity. No walk outs, just quiet persistence. We must have the confidence to set out a new design for two Europes — a wider and an inner — that will live alongside, in harmony with each other...

...I think a dividing line along these lines in Europe will soon become fairly clear cut. It will become an inescapable choice with the pace forced by the urgent needs of the eurozone. Probably a decision in principle will need to be taken in the UK before the fixed term date for a General Election in 2015. There will, if the past is anything to go by, be for some months the usual British reluctance to face up to the reality of this German-French plan. It, incidentally, will not change much if Sarkozy loses in France in May or Merkel loses to the Social Democrats in 2013....

...Any UK political party that ignores the rapidly emerging challenge in Europe is putting its head in the sand.

Westerwelle's comments illustrate how some important people are thinking around Europe and that the UK needs to prepare itself for this hugely important conversation sooner rather than later.

Today, the Fresh Start Project, the group of MPs calling for a new approach to UK relations with the EU, will launch its first Green Paper chapter, covering EU social and employment law.

Co-leader of the group, Andrea Leadsom MP will appear on BBC 2’s Daily Politics show at lunchtime to explain that the Project is looking at the impact of the EU on the UK, and evaluating and proposing options for change. With the help of ideas supplied by Open Europe and other think tanks, this will culminate in the publication of a draft Green Paper on European Reform by July 2012 and a draft White Paper by Dec 2012.