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Tuesday, October 30, 2012

Cameron’s EU budget veto is a powerful tool for change

Over on the Telegraph blog, we argue:
Labour has joined the battle over the EU’s next long-term budget. The budget, to run between 2014 and 2020, will be discussed at an EU summit on 22 and 23 November. David Cameron wants a “real terms freeze” (based on the cash that was paid out from the 2011 EU budget), Labour says he should go for a “real terms cut”, though it is not clear how that is defined. A motion will be debated on Wednesday in Parliament calling for a cut in the EU budget. It’s not binding, but if Labour MPs side with Tory backbenchers it could be embarrassing for the Government. The discussion is generally confused. 
Cameron is running short of allies in Europe for his real terms freeze – the Swedes and the Dutch are still with him. Cameron looks unlikely to back down, however, and it may come to him vetoing it. So what happens if Cameron vetoes the EU budget? The spin from some is that the talks move to QMV, and Cameron is toast anyway.
It’s a bit more complicated than this, however. If there’s no agreement by the end of 2013, there are two, broad possible outcomes:
Carry over the current EU budget:  If EU leaders fail to reach a deal before the end of next year, the 2013 budget structure is carried over, adjusted to inflation (the standard GDP deflator of 2pc). How the cash is allocated is decided by Qualified Majority Vote (QMV) rather than unanimity, circumventing the UK’s veto.
The point is that the UK uses 2011 payments as its baseline figure and this is likely to be considerably lower than the budget allocations or the overall ceiling for subsequent years. The combination of QMV and switching baseline scenario could therefore substantially increase the size of the EU budget, compared to both Cameron’s proposal and the various compromise deals floating around.
Tear up the budget completely and create a new proposal: The European Parliament could go rogue, tearing up the so-called “inter-institutional agreement” between itself and EU ministers, meaning that each year the Commission has to table a completely new proposal for the annual budgets although without any spending ceilings. These, also, will be subject to QMV.
So is Cameron’s veto pointless? Not at all. For a range of reasons, many EU countries would will desperately want to avoid this minefield:
  • Under a “no deal” scenario, EU leaders will need to decide some 55 separate EU spending areas, through individual QMV decisions, all subject to a cobweb of disagreements. This would be hugely time-consuming.
  • The powerful block of new member states would lose out massively from the previous year’s deal being carried over, since under the new budget period they are expected to receive proportionately more money. They will badly want a new deal.
  • In addition, the UK isn’t the only country with a “rebate”. But unlike the UK’s rebate, all other budget corrections – including the Swedish and Dutch rebate on the UK’s rebate (yes, there’s such a thing) – will expire in 2013, while the UK rebate remains constant (courtesy of Margaret Thatcher). Many net contributors are therefore keen on a new deal.
  • For its part, it would take a lot of nerve for the European Parliament – which is already struggling with democratic legitimacy – to tear up the inter-institutional agreement altogether (I dare them).
There’s another twist involving the UK’s rebate which may not make an ad hoc deal appear that bad for the UK either. Even under  Cameron’s “freeze”, the UK’s net contribution could go up by between €1bn (2.2pc) and €2.4bn (5.4pc) over seven years, as more cash would go to new member states not covered by the UK rebate. Under a “no deal” this effect may be mitigated to a significant extent, meaning the UK’s net contribution wouldn’t be greatly affected (for the detail, see here).
Cameron could have done some other things – including repatriating structural funds for richer member states – but at least he’s trying to achieve some change and do the right thing.  Ultimately, this episode shows just how politically and economically unsustainable the EU budget is. It needs to be one of the first items up for re-negotiation as the UK seeks new EU membership terms.

Monday, October 29, 2012

About that Spanish bad bank...

The Bank of Spain has just made an announcement regarding the country’s bad bank plan which fleshes out more details of the proposals following the recent consultation period. The press release and presentation are here and here, respectively.

Key points:
  • The bad bank (known as Sareb) will be a for profit company (expecting a 'conservative' return on equity of 15%), majority owned by private investors (read other Spanish financial institutions) with a minority government stake. It will have 8% capital. 
  • Its duration will be up to 15 years. 
  • A transfer of up to €90bn of assets will take place in two stages. Stage 1 will see around €45bn in assets transferred from the most troubled (already nationalised) banks. Other banks will transfer assets in a secondary stage. (See picture below for the timetable). 
  •  The valuation of assets will work from the baseline scenario of the Oliver Wyman stress tests (which we analysed here). It will be adjusted for the ‘costs’ of transferring the assets to Sareb. (See below for a breakdown of rough valuations). 

More details are still to come but here are some of our initial thoughts:
- One phrase that caught our eye was this: “The transfer price is not a reference for the valuation of non-transferred bank assets.” According to whom? Surely just asserting that this is not reference for the valuation of assets means nothing unless the market agrees? As we saw with NAMA, the market will still price broader assets of the prices used in the transfer, hence long standing market distortions in Ireland.

- The delayed/staggered nature of the transfer of assets could create a two tier market for similar assets, since the ones valued in the bad bank will be valued much lower than those kept on by the viable banks. This could hamper the viable banks attempts to sell off assets at reasonable values.

- The write downs, although substantial, still seem lacking in areas (not least due to the flaws in the OW baseline stress test scenario). For example, assuming foreclosed land will be worth 20% of previous value may seem substantial, but when there is an real estate oversupply which could take a decade to unwind the prospect of this land being worth anything soon seems unlikely.

- The timeline looks positive with significant progress expected in the near future, however, the full transfer of all assets to Sareb could run well into middle 2013. This delay could drag out the issue and further distort the price discovery in the Spanish real estate market. Also as Zerohedge points out, this timeline may be fine in a vacuum but with everything else going on in Greece, problems could escalate quicker than expected.

- As we’ve noted before, although the private investment is positive, it looks likely to come from mostly other Spanish institutions. This furthers the ‘nationalisation’ of banking sectors and intertwines the problem banks with the healthy banks. 
- The plan seems to be, since the institution is not a majority owned by the government, that it will not appear in general government liabilities. It's not clear whether this will pass muster with Eurostat, or how any losses/transfers from the public sector will impact government finances.
Overall then, a bit of a mixed bag. Some positive plans and it’s good that the plan is progressing (if a bit later than desired) but still plenty of potential pitfalls.

Revising the Greek bailout: Two more years of extend and pretend?

Open Europe published a new flash analysis on Friday, which looks at the prospects of a revision to the Greek bailout. It now looks almost certain that Greece will receive a two year extension to its fiscal consolidation and reform programme. However, questions remain over how much it will cost and how it will be funded. Open Europe estimates that the extension would cost a minimum of €28.5bn, if Greece meets all its targets. Meanwhile, none of the options for providing the funding looks politically or economically palatable.

The €28.5bn comes from: an extra €14bn due to slower deficit reduction, an extra €12bn from reducded privatisation receipts and an further €2.5bn from increased government arrears (unpaid bills).

We examine six key options for filling this gap:
1. A reduction in interest rates - which looks very likely but could only deliver €2bn - €3bn.

2. Increased short term debt issuance and more austerity - this looks possible and could deliver anywhere between €15bn - €20bn.

3. Extending length of loans to Greece - unlikely, it could raise €9.1bn in the short term, but on net it would give zero reduction.

4. ECB forgoing interest and/or profit on its Greek bonds - looks very unlikely, but could yield €1.15bn - €2.3bn (interest rate cut) and/or €14.25bn (forgoing profit).

5. Bond buybacks - again very unlikely, but it would mark a much larger step than simply covering the funding gap, as it could deliver €45.65bn overall and €17.15bn after the two year extension is paid for.

6. Write-down original eurozone bilateral loans -  this would be a huge step and could provide €26bn to €52bn but looks very unlikely to be approved, especially as it would support in national parliaments. 
Overall then, its hard to see how the gap will be filled without some larger decision being taken over the future of Greece in the eurozone. To read the full note, click here.

Friday, October 26, 2012

Never mind the Tories – What will Labour do about Europe?

Over on the Guardian's Comment is Free section, we argue:

When talking to diplomats, policymakers and journalists from around the EU, by far the most common question I get is: "What do you think the Tories will do on Europe?"
That question may soon have to be revised. It may not be the Tories, but the Labour party that will decide Britain's place in Europe – possibly even pushing it out altogether.
Much can happen before 2015, but there is a possibility that the Tories could suffer defeat at the polls at the next elections. Then Brussels' biggest fear – a sweeping Tory-led renegotiation of the UK's EU membership terms – will not materialise, at least not any time soon. Instead, either as part of a Lib-Lab pact or majority government, the ball will be in Labour's court. So what will Labour do?
In its 2015 election manifesto, the Conservative party could well promise renegotiation followed by a referendum on the result. It's far from set in stone, but increasingly likely. Tory scepticism on Europe as an issue may not allow David Cameron to get away with less. Labour effectively has two choices in how to respond:
Option one: Gamble on Europe not being an electoral issue.

The thinking is that the EU always ranks low on the list of voters' concerns. National elections are never fought over Brussels. This is only partially true. Europe is a low priority if presented as a single issue – but the fact is, it's not. To varying degrees, it permeates other issues such as the economy, general trust in politicians and, most importantly, immigration (which consistently ranks high) – something that is likely to be established by the current government's "balance of competences" review. Labour could try ducking the question in a campaign, but if the Tory party manages to successfully tap into the public's growing hostility towards the EU status quo – and with the eurozone's demands for greater integration unlikely to go away – it could really hurt Labour.
Option two: Promise a referendum of their own and so neutralise the Tories' pledge.

The Labour party is unlikely to promise a public vote on a renegotiated EU deal – in large parts, they have already rubbished the idea – so it will have to be a straight in/out vote. The plan would be to call a referendum shortly after the elections, campaign for a yes, win the vote and move on to other business.
This would be a massive gamble. The experiences of François Hollande in France and Mariano Rajoy in Spain show that political honeymoons are rare in today's EU politics. And heaven knows what Europe and the British economy will look like in 2015/2016, with the Greek bailout package set to expire, for example. If the referendum coincides with, say, a major new drive for more EU integration, with fresh demands put on the UK; and with a large number of Tories campaigning to leave (more likely in opposition), the British public may be pushed over the edge. It would then be Labour that unintentionally pulls the UK out of Europe.
There may be some options in between, such as promising a referendum on forthcoming treaty changes – or pledges to pursue some milder reforms – but that will not sound overly convincing. And even leaving aside the referendum issue, Europe could hit Labour like a steam train: in a few years' time, the free-standing "fiscal treaty" is meant to be incorporated into the EU treaties. Will Labour nod that through, given that it effectively codifies the Bundesbank-style austerity, much criticised by Ed Balls and co? Will it veto Germany's plans for a fiscal discipline commissioner, if they materialise? How will it relate to the evolving eurozone banking union and potential accompanying treaty changes? Will it tear up the coalition's EU "referendum lock"? The more the eurozone agrees to do in common, the harder it will be for the UK to stand still. In fact, the eurozone crisis means that the status quo is no longer an option for Britain.
The problem is that, fundamentally – and much like the Tory leadership itself – it does not yet appear that Labour knows what it wants for the UK in the multi-tier Europe that is developing. The previous Labour administration's policy of simply sitting in the "euro waiting room" and hoping the public would come along for the ride is no longer credible. However, the wing of the party that said it always opposed euro membership has yet to articulate what its alternative plan is.
There are a lot of good and clever people on Labour's front benches. So far, it has suited Labour to treat Europe as a coalition piñata. Not for much longer. Labour now has the chance to develop a coherent and positive European vision and a plan of its own – designed around a flexible model for EU co-operation, in which Brussels does less in the UK, but does it better. Bank on the status quo or Tory splits, and both the party – and Europe – may be in for some unexpected surprises.

Tuesday, October 23, 2012

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.

Hague's first Europe speech moves the Government in the right direction

William Hague’s first major (and long overdue) speech on Europe since coming to office struck a refreshing tone. In Berlin this morning, the Foreign Secretary set out a case for economic reform in the EU and a new vision for Britain’s place in Europe that was both robust and intellectually consistent. This was the thrust:

“The Eurozone countries must do what they must to resolve the crisis, but the way forward for the EU as a whole is not more centralisation and uniformity but of flexibility and variable geometry, that allows differing degrees of integration in different areas, done in ways that do not disadvantage those that do not wish to participate in everything, and preserves the things we all value.”  

It seems to signal a new tone, if not a new approach, by the Government. Gone was the needless and fruitless lecturing of the eurozone, the counterproductive demands for Germany to pick up the tab for the crisis and the intellectually inconsistent approach that has characterised the UK Government’s rhetoric to date. In short, it has been a complicated mix of demands for a federal eurozone, while threatening to veto the very same thing - 'eurosceptic fiscal federalism' as we've dubbed it. 

Instead, Hague offered a different, far more sensible approach,

“Clearly the Eurozone’s current structures are not working. We respect the democratic decision of the countries of the Eurozone to preserve it. That will require changes. We know the options. It is not for Britain to tell you what the exact remedy should be.”

In fact, Hague held up Germany as a positive economic role model:

“Others can learn lessons, Britons among them, from Germany’s policy choices: structural reforms, its sound public finances and its culture of excellence and enterprise have made Germany globally competitive. It is one of the great trading nations of the world.”

We would hasten to add, this model did not involve cheap central bank cash to paper over deep economic cracks - which seems to be what some members of the UK Government are suggesting the eurozone moves towards. However, the Foreign Secretary still avoided sounding soft. He reminded the German audience that the UK public’s scepticism of the EU is at an all-time high:

“I must also be frank: public disillusionment with the EU in Britain is the deepest it has ever been…People feel that the EU is a one way process, a great machine that sucks up decision-making from national parliaments to the European level until everything is decided by the EU. That needs to change. If we cannot show that decision-making can flow back to national parliaments then the system will become democratically unsustainable.”

He repeated the theme, first developed in David Cameron’s Conference speech, that Europe is losing the global economic race:

“If we do not succeed in making our economies globally competitive and generating sustainable growth then whatever else we do, whatever treaties we sign, whatever structures we build, whatever declarations we sign, will all ultimately be irrelevant. There will be no Social Europe, there will just be an Excluded Europe.”

He also repeated the obvious, yet important, British view that future eurozone integration would have to be compatible with the Single Market:

“While developing a governance of the Eurozone that really works we must equally ensure this leaves the Single Market coherent and intact. The debate on establishing a full banking union shows that this will be complex and sometimes difficult. There are obvious issues for countries not in the Eurozone, for whom it will never be acceptable to have a situation in which the Eurozone acts as a bloc in Single Market institutions in a way that determines the outcomes before the others have even met.”

But, most interestingly, Hague started to articulate a vision of the EU that the UK might be at home in:

“Often important things will not be agreed or cannot be done through the EU. It would be neither right nor realistic to think that questions of war and peace could or should be decided by QMV. Indeed, just because some things work well in coordination with all of our European partners does not mean we should do everything at 27. A more effective EU does not have to mean a bigger, more expensive or more centralised EU.” 

“…The EU is already a diverse place and with further enlargement it will become more so: by the time all the Western Balkan nations join there will be more than thirty countries in it. Its peoples do and will want different things from the EU. Some will be in the Eurozone and some not. Some are comfortable with ideas of federalism, other are not. Some, like Britain, play an active part in foreign and security policy, others find its practice difficult. Some yearn to go further in opening up markets. Others find the idea threatening.

We should recognise and embrace that diversity – it would be a dangerous denial of reality to wish it away. We must respond to what our people and democratic institutions are saying – not just in Britain, but across Europe.”

This was not the finished article by any means but it did signify that the Government (or at least its Conservative part) might finally be coming around to the idea that it needs to explain to the rest of the EU - and UK voters - what it wants from any future renegotiation (Hague also outlined the UK’s review of EU powers), and where the referendum will fit in.

The question is whether Cameron’s much anticipated speech this autumn will deliver.

Spanish regional elections: Why the victory for Rajoy's party in Galicia should not be overplayed

Following the latest round of regional elections in Spain on Sunday, the foreign media clearly seem to have focused their attention on the victory of Spanish Prime Minister Mariano Rajoy's Partido Popular (PP) in Galicia (see, among others, this article from today's FT). Of course, the fact that outgoing Galician President and PP candidate Alberto Núñez Feijóo (pictured with Rajoy) has not only confirmed his absolute majority, but also managed to consolidate it by winning three more seats than he had during his previous term is remarkable, given the nationwide drop in the party's popularity.

However, the significance of the victory in Galicia should not be exaggerated, for a number of reasons. Firstly, Rajoy is Galician. Although, as noted by the Spanish press, he avoided appearing next to Feijóo during most of the electoral campaign, Rajoy did travel quite a lot across the region - and it would be naïve to think that his personal involvement did not win Feijóo a few extra votes.

Secondly, Galicia is a region with solid right-wing credentials. The region has been governed by centre-right forces for much of the time since Spain returned to democracy - including fifteen consecutive years between 1990 and 2005 under Manuel Fraga Iribarne, a former minister under Francisco Franco (a Galician native himself) and the founder of Alianza Popular in 1976, which became Partido Popular in 1989.

Therefore, we definitely think the results of the Basque elections were far more interesting - for one very simple reason. Unlike after the previous elections in 2009, Rajoy's Partido Popular and the opposition Socialist party together do not command a sufficient majority to stop the candidate of the Basque Nationalist Party (PNV) Íñigo Urkullu becoming the region's new President - although he will need the support of other parties to secure a majority in the Basque parliament.

It is not unusual for nationalist parties to be in government in the Basque Country, but the context looks quite different this time. During the electoral campaign, Urkullu has clearly said that he wants to make the Basque Country a "European nation". The expression must sound worryingly familiar to Rajoy and his cabinet, as it clearly echoes Catalan President Artur Mas's recent calls for Catalonia to become "a normal nation within Europe".

Incidentally, a new Feedback poll for Catalan TV channel RAC1 this morning credited Mas’s party with 67 seats in the 25 November regional elections – only one seat short of an absolute majority in the Catalan parliament. The same poll also found that over 70% of Catalans are in favour of pushing ahead with plans for a referendum on the relationship between Spain and Catalonia, even if the Spanish government prohibits it.

The Catalan elections are yet to take place, but there is clearly the potential for a major 'sovereigntist' headache here - and at a time when the Spanish government can least afford it.

Monday, October 22, 2012

Eurozone votes for eurozone laws: one way to solve the European Parliament’s “West Lothian question”

In the UK, Scottish MPs can vote on English matters (such as the English NHS and education etc.) where, because they are devolved to the Edinburgh parliament, English MPs have no say on specific Scottish matters. This has been labelled the “West Lothian Question”. Solving it is has been a perennial subject for debate, going way back to debates on Irish home rule in the 19th century right through to Scottish devolution. As yet it remains unanswered.

With a multi-tier Europe becoming more of a reality every day, in wake of further Eurozone integration, the EU is now facing its own West Lothian question. If some countries don’t take part in say, more fiscal integration or if some countries – such as the UK – wish to devolve some EU powers back to the national level, how would the EU’s voting system take that into account?

European Parliament President Martin Schulz said yesterday for instance in an interview with
Die Welt, that:

"it can't be the case that individual member states pull out of the common [policy] areas, but believe that they can continue to co-decide on legislation. That's the case for negotiations in the Council, but also in the Commission and for us in the Parliament. The withdrawal of Great Britain raises the second big question apart from the euro question: how do we deal with this now from a legislative perspective? With Schengen, it was already the case that London doesn’t take part but was allowed to co-decide on legislation. We must make this systematic. When Cameron starts picking what he prefers from current Treaty law, we must consider which consequences this has for us as an institution. Whoever doesn't take part in certain policies, should no longer take part in the legislative process. When you withdraw, you need to withdraw completely.”

And he is also quoted by DPA as saying:

“The euro is the currency of the union. The parliament of the union is the European Parliament. Thus the parliament of the euro is the European Parliament. We have 27 EU member states and two, namely Denmark and the UK, said we won’t go along with the euro. All other states are required to introduce the euro sooner or later. Therefore we need a ‘27 minus’ approach on EP decisions on Eurozone-specific issues”.
Schultz has asked the West Lothian question
- but does he have the answer?

Schultz seems to be arguing for the eurozone votes for Eurozone laws. He makes a good point, but how would this work? Well, Britain has some experience of assessing the relative merits of limiting MPs to voting on different laws. In essence the problems that have been thrown up are these:

Problem in UK: How do you ascertain what is a ‘eurozone’ law is when something might effect both parts? 19th Century British PM William Gladstone, for instance, concluded that: "it passed the wit of man to frame any distinct, thorough-going, universal severance between the one class of subject and the other."

Not a problem in EU: In the UK these problems remain due to the imprecise nature of UK governance. However, in the EU all legislation is based on treaty articles and EU competences, so deciding who votes on what should be far easier, though if the line between the banking union and the single market, for example, gets blurred this could suddenly become problematic.

Problem in the UK: English votes for English laws in the UK raised the prospect of a UK government unable to govern England because, it may not in fact command a majority of English MPs (only an ‘overall’ majority) creating constitutional chaos (think posts such as the Home Secretary).

Not a problem in EU: In an EU context allowing differing governments to get on with their business would probably suit the UK just fine, as would limiting MEPs’ power over UK affairs (though we acknowledge the risk of eurozone caucusing etc).

In principle, there’s no reason why variable geometry in the EU voting system can not be made to work – in fact, it could be an important component of a reformed EU, in areas such as the CAP, JHA and social and employment laws, as per the model we’ve outlined below. When these are up for discussion a UK MEP would simply not vote.

Politically, it would need to be managed very carefully. Some euro-outs, such as Sweden, will probably oppose such a differentiated approach. But it would be fair democratically and, as Europe moves towards a multi-tier model, perhaps something the EU will eventually get used to.

Will eurozone votes for eurozone laws catch on in a multi tier EU?

Friday, October 19, 2012

Spanish regions: We hate to say 'We told you so', but...

In July, we published a briefing looking at the potential impact of regional debt problems on the Spanish economy. In particular, we noted that Spanish regions were expected to make swingeing cuts to meet the overly ambitious regional deficit target of 1.5% of GDP by the end of the year. Based on the size of cuts each region had agreed on with the Spanish government, we drew the 'traffic light' table below:

Three months later, it's time for an update. Following today's bailout requests from the Balearic Islands and Asturias, eight of 17 Spanish regions have decided to tap the €18 billion bailout fund set up by the Spanish government. And guess what? Four of them (Castilla-La Mancha, Comunidad Valenciana, Murcia and the Balearic Islands) are in the 'red' area of our table - i.e. among the regions that, according to us, had agreed to unattainable deficit reduction targets for this year. Catalonia, Asturias and Andalusia - top three in the 'amber' area - have also sought help from Madrid. To date, Canary Islands are the only surprise, as they have requested a bailout despite having to make the smallest deficit adjustment of all Spanish regions.

With only less than half of regions covered (although, of course, not all of them will need financial assistance), the Spanish government's bailout fund for regions (which totals €18 billion) has almost run out of money. Here is what each region has requested:

Catalonia: €5.4 billion
Andalusia: €4.9 billion
Comunidad Valenciana: €3.5-4.5 billion 
Castilla-La Mancha: €848 million
Murcia: €641 million
Canary Islands: €757 million
Balearic Islands: €355 million
Asturias: €262 million

TOTAL: €16.7-17.7 billion

So, if all regions obtained the entire amount they have asked for, there would be almost no money left in the pot - and two more regions in the 'red' area which may well need assistance (the case of Galicia is slightly different, as we explained in our briefing). This is why the Spanish government is trying to hold off on at least part of the loans. It has, for example, agreed to lend Andalusia only €2.1 billion, and €2.5 billion to Comunidad Valenciana - for the moment. However, regional governments will presumably push to get all the money they asked for - which in turn increases the likelihood that the bailout fund will need a top up.

We remain of the view that regional debt problems will not 'make or break' Spain financially, although depending on how the payments are handled they may increase Spain's deficit - as will the fact that the regions are still likely to miss their targets for this year. In any case, though, in the eyes of Spain's eurozone partners and the European Commission, every additional region tapping the bailout fund adds to the impression that the Spanish government is simply not capable of keeping regional spending under control. For once, we agree with the EU/IMF/ECB Troika on something.

Banking union: moving forward or standing still?

Media reports on the outcome of eurozone summit discussions last night are mixed, but there is general theme that eurozone leaders have taken ‘a step closer to banking union’. Looking at the latest conclusions  (see here),we wouldn't quite describe it as a step closer - at least not a big step.

·         The timetable (which everyone admittedly knew was unrealistic) has been delayed. Previously the eurozone was insistent on the single supervisor being up and running by the start of 2013, now it is some point during 2013 (with strong suggestions that this will be after the autumn German elections).

·         There is discussion on including / accommodating non-euro members but no detail on how this will be done (particularly in reference to Sweden, Poland but also the UK) or how the recently publicised legal concerns within the Commission will be dealt with. There is expected to be a substantial amount of progress on tricky legal and political issues before the end of the year.

·         The one point of agreement was that the ECB will supervise all 6,000 eurozone banks, seemingly a positive step on the surface. However, in a concession to Germany, it was also established that much of the day to day running of the supervision of smaller regional banks would still be conducted by national financial supervisors. This raises further difficult questions about the already poorly defined relationship between the ECB and national supervisors.

·         The leaders simply reaffirmed that the ESM, the eurozone’s bailout fund, would be able to recapitalise banks directly once the single supervisor is in place – but this was never in doubt. The real question over whether the ESM can retrospectively take on the burden on bank recapitalisations, relieving ailing governments of the problem, was left unanswered with little discussion.

·         There was another call for the harmonisation of deposit and resolution schemes across the eurozone – an issue which has already been delayed by two years due to political posturing. More importantly, talk of a combined backstop and resolution mechanism for the banking union was kicked into the long grass. As we said before, that element of banking union is, at best, years away.

·         Lastly, we still find it hard to see how the EU can hold a meeting and not find time to discuss Spain or Greece in detail, given that their problems are the most immediate concern.

So more standing still or treading water. Again this reinforces the fear that, as soon as the financial and economic climate looks slightly more positive, any hope of progress on the tough decisions goes out the window.To be fair though, as Swedish PM Fredrik Reinfeldt likes to say, the most important thing is to get it right.

Thursday, October 18, 2012

The key to understanding the eurozone crisis: sequencing

An EU leader saying that he or she is in favour of “more Europe” in response to the Eurozone crisis means absolutely nothing. Ask Germans whether they’re in favour of more Europe, meaning codification of Bundesbank-style fiscal discipline at the EU level, using the EU institutions to enforce it, and naturally they will nod approvingly. Ask them if they want joint EU borrowing or backstops for banks, and support for “more Europe” evaporates. Shock horror, in countries more prone to tax and spend – and here we include France – the trend is pretty much reversed.

The key to understanding the next step in the Eurozone crisis therefore comes down to one thing: sequencing. The Germans want surveillance before solidarity (code word for more cash on the table). The French the opposite. Which is why it’s not surprising that Angela Merkel and Hollande are clashing over the former’s idea to stick an EU veto on national budgets (her finance minister has proposed a fiscal tsar, sitting in the EU commission, to do the job).  Merkel says she wants “genuine powers to clamp down on national budgets…that we stick up for this won’t change”. Translation: if you want our credit rating, you need to accept our Ordnungspolitik. For his part, Hollande stresses intégration solidaire - ‘integration with solidarity’. Translation: cash first, budget vetoes later (sort of).

We’ve made this point several times before, but it keeps on reasserting itself. The see-you-in-court fiscal controls that the Germans need as political cover (and as a safeguard against moral hazard) to press ahead with transfers are incredibly difficult to achieve politically, as they effectively mean redefining national democracy in debtor states (key decisions on spending and taxation would no longer ultimately be subject to decisions in national parliaments).

The question is what the absolute minimum level of fiscal control the Germans can accept to press ahead with the next step. This is why Herman Van Rompuy's proposal for a contract-style agreement between an individual country and an EU institution, resting on a paid-in insurance scheme (of sorts), could be an interesting to watch. If sold as "temporary" (which of course it may not be at all) and linked to reforms, that might be easier for Germany to swallow.

But at the moment, we suspect Angela Merkel herself doesn’t know the answer to that question…

Wednesday, October 17, 2012

François wants to chat...

Ahead of tomorrow's EU summit, French President François Hollande has decided to give a lengthy interview to several European dailies (including the Guardian, Italy's La Stampa, Spain's El País and Germany's Süddeutsche Zeitung). The full interview - the first major foreign interview since Hollande was elected last May - is due to appear in tomorrow's print edition of these papers, but is already available on Le Monde's website.

The French President made some interesting remarks about Germany's role in the eurozone crisis:
The return to growth involves mobilising funds at the European level – which is the [growth] pact we adopted [at the EU summit] in June – but also improving our competitiveness, and, finally, coordinating our economic policies. Countries running a [trade] surplus must stimulate their internal demand through salary increases and tax reductions – this is the best expression of their solidarity.
Well, Germany is not mentioned here, but the reference is obvious...

Hollande also said,
We all take part in solidarity, not only the Germans! The French, the Germans, as well as all other Europeans within the framework of the European Stability Mechanism [the eurozone's permanent bailout fund]. Let’s stop thinking that there is only one country paying for all the others. This is false! Nonetheless, I know our German friends are sensitive about surveillance. He who pays has to control. He who pays has to sanction. I agree. But budgetary union must be completed by the partial mutualisation of debt: through the Eurobonds.
And then something specific about German Chancellor Angela Merkel,
She is outspoken, she says things…This saves time. And I have the same attitude…Indeed, we are not in the same time scale. I was elected five months ago, and the Chancellor has her elections in ten months – but this does not lead us to defer choices.
The language used is certainly diplomatic, but the message to Berlin is clear. First, Germany should bear in mind that there are other countries paying for eurozone bailouts. Second, that debt pooling remains high on France's agenda.

Hollande also addressed the issue of UK-EU relations,
I would like a United Kingdom fully engaged in Europe, but I can’t decide for the Britons. I’ve noticed that, for the moment, they want to be rather in retreat. The Britons are bound by agreements which they signed up to. They can’t detach from them. They now at least have the merit of being clear. The eurozone, the budgetary union: they are not in them. I do not intend to force them.
He added,
I’m in favour of monthly meetings of eurozone heads of state and government…This Eurozone Council will allow us to better coordinate economic policies and make, country by country, the appropriate decisions. It’s not about excluding the other countries: those who want to join the eurozone will be associated to our debates. Certain countries do not want to – it’s their choice. But why would one need them to come and tell us how to run the eurozone?
Finally, some thoughts on the next steps of European integration,
France defends the idea of ‘integration with solidarity’ [intégration solidaire in French]. Every time we take a step towards [greater] solidarity, the union – that is, the respect of common rules – must progress too.
Political union is for later. It is the stage which will follow budgetary union, banking union, social union. It will give a democratic framework to what we will have achieved in terms of ‘integration with solidarity.’
This is not new, but a clear indication that France and Germany are on opposite sides with regard to whether surveillance or solidarity should come first.

It is also rather telling that the democratic framework or political union underpinning Hollande's vision "is for later"...

Tuesday, October 16, 2012

European regionalisation: do two negatives make a positive?

As we've argued before, there's a lesson for the eurozone to learn from the all the semi or full-blown separatist movements across Europe; trying to impose central control on an inherently regionalised structure is extremely difficult and artificially imposing a top-down identity remains as challenging as ever. At the same time, should a region choose to leave an EU county it could, after negotiations, be absorbed by the European structure, which in turn would have a stabilising effect on the tumultuous politics that will follow.

Therefore, separatist movements across Europe simultaneously showcase both the weakness and strengths of the European project. However, what's clear is that the austerity sweeping Europe is not only creating tensions between national capitals and Brussels, but also national capitals and regions. Just in case you thought the eurozone was on the verge of a agreeing a transfer union....


The Flemish are as unhappy as ever about their domestic transfer union, and this weekend, local elections in Belgium saw the moderate Flemish nationalist N-VA party make substantial gains, using the €16bn a year that Flanders sends to the Francophone region as a political springboard. A leader in Belgian daily De Morgen notes that that the N-VA's objections to "the left-wing tax government of [Belgian PM Elio] Di Rupo don't differ that much from "the criticism in other countries of the [eurozone] solidarity mechanism which keeps the Greeks or Spaniards afloat".


In Spain, the Catalan independence movement is stepping up a notch off the back of Madrid (and Brussels) imposed austerity measures. In September, a pro-independence rally in Barcelona (pictured) mustered between 600,000 and 1.5 million people depending on whether you ask the Catalan or national police. The Catalan government has said it wants to hold a referendum on independence, with a majority of Catalans in favour according to some polls. A motion to permit a referendum was voted down by a majority in the Spanish lower house and could trigger a constitutional crisis if Catalan PM Artur Mas goes ahead with the plans regardless. Spanish Prime Minister Mariano Rajoy has said holding a referendum without the central government's approval would violate the Spanish Constitution.


The Lega Nord party has been calling for the separation of Italy's northern regions from the rest of the country. Possibly the main difference between the Italian case and the others, is the fact that the geographical entity evoked by Lega Nord (the so-called 'Padania', including all the regions above the Po river) has never existed as an independent state. Furthermore, Lega Nord has usually been more or less aggressive in its pro-independence claims depending on whether the party was in government or in opposition. Nonetheless, many northern Italians do feel that too big a chunk of the taxes they pay is then used to fund 'dysfunctional' Southern regions. Potentially one to watch, especially if Lega Nord (as it looks likely at the moment) will stay in opposition after next year's elections. 


While there is no talk in Germany of an independent Bavaria just yet, in July the regional government announced that it will launch a complaint at the German Constitutional Court against the German system of "Equalization payments" between richer and poorer German Bundesländer. Bavaria is the main net contributor to this system with €7.3bn, sharing the burden with only three other states - Hessen and Baden-Württemberg and Hamburg). The rhetoric of Bavarian politicians on the eurozone crisis has also been notably tougher than that of other German politicians as we've noted here. Meanwhile, a recent Bild poll found that 46% of Germans were against the separate West-East solidarity income tax levy compared with 42% in favour.

United Kingdom 

In Scotland the Scottish National Party has won its battle for a independence referendum with Scots being given a single Yes/No question on independence to be held in 2014. The prospects of Scotland becoming independent have however, in contrast to other regions, been damaged by the eurozone crisis with previously favourable comparisons with Ireland and Iceland being turned into examples of the problems of small economies with oversized financial services industries. Other questions that are beginning to be asked are whether an independent Scotland will use the euro (decreasing in popularity) or retain the pound, remain in the EU or have to have border controls. It has also been noted, including by the EU Commission, that Scotland would have to negotiate its EU membership afresh rather than opting in by default off the UK's entry in 1973.

Meanwhile in Brussels...

European Council President Herman Van Rompuy has presented a report calling for a central eurozone 'Treasury' with a shared budget and eurobonds - very close to a full-blown trasnfer union.

In Brussels, the logic seems to be that two negatives make a positive.

A virtual Spanish bailout?

In case you’re wondering, we not talking about a bailout on Facebook or the like.

No, we’re referring to the quite strange comments by a Spanish finance ministry official reported in the press this morning. The official reportedly stated that Spain does not see a bailout request as imminent or immediately necessary but would be comfortable making the request for a precautionary credit line in order to potentially access the ECB’s new Outright Monetary Transaction (OMT) programme. All par for the course you would say, but the comments that really caught our eye were the following, via the FT and the WSJ:
"The credit line is not fundamental, it is circumstantial…One could say it's a virtual credit line,” adding that Spain will likely not access any of the money from the ESM, while the ECB may not even have to buy any bonds. 
Let us elaborate, because this seems to amount to a bailout without any money. Essentially, the suggestion is that Spain would sign a new Memorandum of Understanding (MoU), which wouldn’t include any new reforms or conditions, allowing it access to ESM money if it ever became necessary. This would supposedly satisfy the OMT requirements allowing the ECB to intervene in the secondary market for Spanish bonds if borrowing costs for Spain once more reach unsustainable levels.

A very neat idea in theory, as with most eurozone proposals, but we have a few concerns:
  • We can’t imagine the ECB or Germany would go for it. Both would likely request stricter reforms and conditions (probably rightly, as we noted recently Spanish labour market reform has some way to go), particulary since it would need approval from the Bundestag. 
  • More importantly, this may fail the ECB’s conditionality requirement. Although, details on the OMT are thin on the ground, the conditionality needs to be enforceable. The conditionality comes from a MoU which is tied to the ESM financial aid. Therefore if the ESM aid is not actually being accessed the conditionality is instantly voided since it cannot be enforced by withdrawing funding (since the funding is non-existent). 
  • A strange situation could arise where the ECB is then buying bonds without the ESM lending money, while no new conditions have been enforced. We’ve warned of the moral hazard and other negative impacts of this at length before. 
  • If the ESM is not lending to Spain but the ECB is buying its bonds surely the MoU and conditions essentially become a direct agreement between the ECB and Spain, putting pay to the view that these actions relate to monetary policy and maintain the independence of the ECB. 
  • As the ESM guidelines on precautionary loans note, they are only available to countries where there are no “bank solvency problems that would pose systemic threats to the stability of the euro area banking system.” We’re sure this will be fudged, with the eurozone suggesting the bank bailout solves any remaining provlems, although we’d maintain that €40bn is far from enough to solve the problem.
  • This is not to mention that Spain has huge funding needs and will in fact need real cash injections at some point, meaning the threat of intervention will surely not be enough to hold Spain over. 
We’ll end with an interesting, if somewhat mixed, analogy from the Spanish official:
“One does not just normally drop an atomic bomb. It has to be co-ordinated and discussed. But we [Europe] are all in the same boat.” 
Quite. As we’ve previously warned the OMT and Spanish bailout needs to be carefully structured, unfortunately a 'virtual bailout' is unlikely to do the trick.

Monday, October 15, 2012

The UK’s opt-out of EU crime and policing law and what happens next

Home Secretary Theresa May today indicated that, in the coming weeks or months, the Government will formally exercise its right to opt out of around 130 EU crime and policing laws. The list of laws subject to the block opt-out includes several contentious measures such as the European Arrest Warrant, those establishing the EU’s judicial and policing agencies Eurojust and Europol, and databases to share criminal records and DNA between member states.

The opt out must be taken en bloc: either the UK opts out of all EU crime and policing measures on the list or it must continue to accept all of them and, from December 2014, the European Court of Justice (ECJ) will have full jurisdiction over them for the first time. So, it is important to remember that this is not simply a choice between the status quo and opting out, but between opting out and granting EU judges the final say over how this body of around 130 laws is applied in the UK.

This year, in An unavoidable choice, Open Europe recommended that the Government take the opt-out as soon as possible, in order to start the process of reconfiguring the UK’s cooperation with other EU member states in the field of crime and policing. Subject to successful negotiations and with adequate checks and balances in place, the UK could then choose to opt back into individual measures considered to be absolutely vital. The UK Government has committed to a vote in both Houses of Parliament on whether the UK should take the block opt-out. Given that over 100 Conservative MPs have already signed a letter in favour of exercising the opt-out and backing Open Europe's report, it would be virtually impossible for David Cameron to get a decision to opt in through Parliament without either the biggest rebellion to date or it being struck down, should Labour also decide to vote against the Government.

What happens next?

The UK retains the right to apply to the EU institutions to opt back into individual measures that it considers to be in the national interest. The UK is likely to want to continue to cooperate in the EU’s criminal databases and perhaps a reformed European Arrest Warrant that contains greater safeguards for individuals facing extradition. Therefore, today’s announcement kicks off a process of negotiation both between the Coalition parties and between the UK and the EU institutions over what the UK opts back into. If the UK opts back in, this is irreversible and the full powers of the ECJ apply.

It is this issue, the potential role of EU judges, which it is vital to consider. The ECJ has a record of interpreting EU laws which centralise power at the EU level and in ways in which national governments do not expect or agree with. In other policy areas this has included banning insurers’ distinction between male and female drivers to price insurance premiums, for example. Once these rulings are made, the EU’s ‘democratic deficit’ really kicks in because overturning such a ruling usually requires a qualified majority of member states and the agreement of the European Parliament. Accepting ECJ jurisdiction is therefore a huge gamble that could backfire on the UK’s justice system.

The UK could, in theory, be refused ‘re-entry’ once it has opted out en bloc. This could happen if, for example, individual opt-ins became subject to conditions from the European Commission or entangled in negotiations over other, unrelated areas of EU policy and the UK needed to horse-trade over an opt-in. The European Commission has pointed that the UK could be faced with a bill for the “direct financial consequences” of the mass opt-out, although there is a degree of scaremongering involved as the cost is not likely to be overly large and, more importantly, it would be a huge own goal for other countries to be seen to put a disproportionate price on democratic choice and debate.

In addition, those that fear the UK’s loss of influence ignore the strength of the hand that the Government has in negotiations to opt back in. The UK is a big destination for other member states’ nationals, Britain receives the biggest number of EU extradition requests and the EU treaties state that the UK and the EU institutions, which in the majority of cases will be the European Commission, “shall seek to re-establish the widest possible measure of participation” in crime and policing.

We also should not forget that the opt-out was negotiated with the other member states by the previous British Government, precisely because it was concerned about the power the ECJ would have over this area of EU law. These concerns remain and, ultimately, the decision over the 2014 block opt-out is a matter of balancing operational expediency against national control and democracy.

The current level of integration in this hugely sensitive area has so far been subjected to a worrying lack of democratic debate in the UK, as it has tended to occur in a piecemeal fashion and outside the glare of media scrutiny. Politicians, the policing and security community and civil society now have the opportunity to debate the issues properly for the first time. This debate will enhance the democratic legitimacy of whatever is agreed and should therefore be welcomed by all involved.

When debating the merits of opting back in to various EU crime and policing laws in future, the Government should be satisfied that it has correctly weighed the following:

1) That the right balance has been struck between civil liberties and national security;
2) The downside risks of how the law concerned might develop in the hands of the EU court;
3) And, most importantly of all, that the decision is in the best interests of British citizens and not the Coalition.

Friday, October 12, 2012

EU and the Nobel peace prize: the once-celebrated actor who just got a life-time achievement award?

It’s common practice in Hollywood to give a life-time achievement award to a once-celebrated actor whose career is in decline. Although he or she hasn't really done a good movie in years, the award acts like a bit of encouragement and/or belated recognition. The exercise is partly driven by appreciation but also has a condescending feel to it, with the implicit suggestion being that your best days are behind you.

When we heard the unexpected news today that the EU won the 2012 Nobel Peace prize, we couldn't help but to draw this analogy. You can almost picture the actor (the 'EU' in this case) – dragging themselves up onto the stage to collect their award despite having since gone through several broken marriages, a series of stays in rehab, and a ton of plastic surgery. It’s all for show – but we can’t help but feel it’s a bit sad at the same time.

As ever with the Nobel Peace Prize, this year’s decision will divide opinion – to put it mildly. British eurosceptics’ blood pressure has already been raised several notches. And equally we don’t want to ruin the orgy of self-congratulation currently underway in Brussels. While Europe’s epic moments have belonged to national politicians and not to Eurocrats, these guys haven’t had something to celebrate since the Irish were forced to vote ‘Yes’ in the second Lisbon referendum; they (sort of) need a bit of a break.

But what’s clear is the EU isn't exactly hot at the moment. Trust in the EU in the Mediterranean – the countries to which the zone of peace and stability spread in the 1980s and who have traditionally been the strongest supporters of the project - has dropped from 55% to 25% in a decade, in the wake of euro-induced pain. Several countries are in recession. Angela Merkel got a pretty rough reaction in Greece earlier this week. Far from uniting countries and fostering “solidarity”, the Eurozone crisis risks driving a wedge at the heart of the European project, between north and south in particular.

But at the same time, to be fair, despite Angela Merkel trying to bundle the two together (a mistake), the EU isn't only the euro. The Nobel committee is right that 'the EU' as a trading block has contributed to stability and peace in Europe, first following WWII and then carrying on throughout the transition of Mediterranean ex-dictatorships and post-Communist countries. The idea of stability through trade is fundamentally a good one, and enlargement is the EU’s only proper foreign policy tool. But the awarding committee, of course, hugely simplifies the issue. The EU is only one of several factors which played in maintaining peace and stability in Europe after WWII; the role of NATO cannot be overlooked in this context.

The saddest (some would describe it as the most ironic) part about the EU’s lifetime achievement award is that through ideological over-reach, political vanity and economically illiteracy, i.e. the Eurozone at 17, much of what Europe has collectively achieved with respect to trade, peace and stability, risks being undermined. The committee should have added this lesson to its motivation: trying to stamp out economic and democratic realities through political and ideological ambition alone never ends well.

PS: Organisations have of course won the prize before – the UN, the inter-governmental panel on climate change, Amnesty international etc – but the debate is currently raging as to who, exactly, will accept the prize. This links to a second question. Who, exactly, did the Norwegians award the Nobel Peace Prize to? Jose Manuel Barroso? Herman Van Rompuy? Angela Merkel – whose taxpayers are currently paying for the party? The European Parliament - many of whose MEPs are under the impression that they are seen as the legitimate democratic voice for European citizens? The head of that fine entity known as the European Social and Economic Affairs Committee (if you've never heard of it, not to worry)? Or the millions of Europeans who travel and trade across borders rather than shooting at each other (and vote for politicians who want them to do just that)? Who, exactly?

If the latter, the Open Europe team is honoured to have received the Nobel Peace Prize – and the roughly €0.0027 each that the prize money comes to. (Nobel prize award of €1,354,045 ÷ 502,489,143 inhabitants = per citizen via @RuadhanIT).