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Friday, November 30, 2012

Barroso's Christmas wish list

Christmas is approaching and, in that spirit, José Barroso, the President of the European Commission, has written himself a wish list of presents for the EU member states (and particularly the Eurozone) to hand over. The Christmas wish list, or as Barroso puts it "A Blueprint for a deep and genuine EMU" is as follows:

For the next 18 months:

Wish number one: the "rapid adoption of current Commission proposals such as the two-pack and the Single Supervisory Mechanism" - i.e giving the ECB powers over eurozone (and perhaps other) financial supervision.
Wish number two: a eurozone "rebalancing" budget in addition to the EU budget. - more money.
Wish number three: a "Convergence and Competitiveness Instrument" for the eurozone - mutual contracts to enforce bailouts and deficits.
Wish number four: "external representation of the euro area in international economic and financial organisations and fora." - some more foreign postings.

And thinking ahead for next Christmas (next 18 months to 5 years):

Wish number five: deeper [eurozone] coordination in the field of tax policy issues as well labour markets
Wish number six: an "autonomous" and enhanced eurozone fiscal capacity that will  "rely solely on own resources" - a eurozone tax, budget and treasury- perhaps a financial transaction tax?
Wish number seven: a "power of intervention in the design and implementation of national fiscal policies"
Wish number eight: "The common issuance... of so-called eurobills", requiring a treaty change - but will the German taxpayer want to underwrite (and perhaps lose) money lent to Greece?

For the Christmas after that (for 5 years time):

Wish number nine: "extend the competences of the Court of Justice, i.e. by deleting Art. 126 paragraph 10 TFEU and thus admitting infringement proceedings for Member States or by creating new, special competences" - i.e further power over national economies.
Wish number ten: "a commensurate involvement of the European Parliament in the EU procedures. The European Parliament, and only it, is that Parliament for the EU and hence for the euro."

And this would leave you with Barosso's ultimate wish: "a banking union, a fiscal union, an economic union [and] as a fourth element, appropriate  democratic legitimacy and accountability."

German Foreign Minister Guido Westerwelle's response to the proposals was: “It is good that the EU commission is putting forward proposals for a stronger co-operation in the eurozone. But eurobonds, bills or any other form of joint debt liability in Europe are going in the wrong direction."

To many the proposals may seem alarming, but in truth, most of these proposals have been floating around for a long time. The novel aspect was the proposed time frame outlined by the Commission and combining them in a single vision. Notably though, many similar proposals by the Commission have resulted in very little, especially since the eurozone crisis has put an increasing emphasis on the intergovernmental decision-making found in the European Council.

Herman Van Rompuy's own list (expected at the December summit) which will probably be more modest and less eye-catching is likely to be more important simply because it more closely reflects the views of the key decision makers in the process.

Thursday, November 29, 2012

Greek banks and the Greek bond buyback

Yesterday we put out a flash analysis looking at the latest Greek deal and the prospect of Greek bond buyback. One of the many issues with the deal (and the buyback in particular) which we raised was that Greek banks will find it difficult to participate without needing extra capital.

However, Greek Finance Mininster Yannis Stournaras also said yesterday (in a timely statement):

The debt buyback "doesn't mean new capital for banks, given that they have recorded these bonds at lower prices than those that will be offered."
His suggestion then, is that the Greek banks have already marked their bonds to market prices on their books, meaning that they can sell them at the low prices involved in the bond buyback without needing new capital. This may make their participation more likely, but there are plenty of other reasons why we still see it as difficult and unpredictable. (We also still question why foreign holders will be involved, particularly previous hold outs and those who are holding to maturity, see our full analysis here).

Firstly, as Kathimerini reported today, the banks themselves are not keen to be involved in the buy back. Many feel that they have already done their part in terms of taking part almost ubiquitously in the first debt restructuring. If they were to take part in the buyback, they could seek adjustments in the terms of the recapitalisation and reform – something which the EU/IMF/ECB troika is unlikely to accept.

Secondly, taking part in such a scheme would need significant approval within the banks and other financial firms. This means board level and possibly wider shareholder approval. As the restructuring earlier this year showed, this takes time, with the process dragging for months. Given the 13 December deadline to have a bond buyback plan in place (i.e. to have a firm idea of who will take part, to make sure it is worthwhile) it is not clear how many bondholders will be in place to participate.

Thirdly, and possibly most importantly, is that the banks need their holdings of bonds (around €22bn) to gain liquidity from the Emergency Liquidity Assistance (ELA) through the Greek Central Bank (GCB). Looking at the GCB balance sheet, it seems broadly that Greek banks posted €247bn in collateral to gain €123bn in liquidity, an average haircut of 50%. Given that many of these assets will be loans or securities, sovereign debt (even Greek) is unlikely to be judged any more harshly than the average. So, if the banks sold these assets for a 65% write down (as suggested) they could purchase new assets (maybe other sovereign debt) but would be able to buy less of it (as not many other assets priced at a 65% discount) meaning they would not be able to gain as much liquidity under the ELA as with current Greek bonds.

Essentially, this could harm the Greek banks liquidity position which would further constrain their lending ability and possibly prompt further deposit flight – both of which would hurt the fragile Greek economy.

All in all then, this process could still be counterproductive for Greek banks even if they do not book new losses directly and they still could be hesitant to take part voluntarily. However, that is not to say that the political pressure applied behind the scenes will not be enough to force them to voluntarily join. Ultimately, it simply highlights that this policy may deliver a small benefit with some negative side effects but is at best a way of skirting the real issue of whether the eurozone can stomach permanent fiscal transfers to Greece. This will come to the fore again soon.

EU farm subsidies - the mother of all misallocations

Its been a busy few days on the EU budget front with the inconclusive EU leaders’ summit on the EU’s long term budget, and the Commission’s new proposal for the 2013 annual budget (largely unchanged from the version MEPs and member states were unable to agree on). Much of the attention in the talks were given to absolute numbers over substance, which is why Tuesday's Court of Auditors' report on the 'single farm payment' – accounting for roughly one third of the EU budget – is very interesting. The CAP as a whole (comprising the rural development component and the remaining market distorting subsidies) accounts for around 40% of expenditure - €56.8bn this year alone.

Specifically, the report looks at the effectiveness of the ‘Single Area Payment Scheme’ (SAPS) which is just EU jargon for the bulk of farm subsidies to most of the new EU12 member states under the CAP (The EU15 states plus Malta and Slovenia have a different support scheme called the Single Payment Scheme. A unified scheme for all 27 states is due to be introduced in 2014. The generic terms for both is usually 'the single farm payment').

The language is, as usual, cautious but it's quite clear that by EU standards, the Court of Auditors absolutely slams these subsidies. In the report’s executive summary we read that:
  • The definition of ‘farmers’ is inadequate leading to subsidies being paid out to "beneficiaries not or only marginally involved in farming". In some of the Member States concerned, SAPS aid was paid to organisations not involved in farming, including public entities managing state land, hunting associations, fishing clubs and ski clubs. So the farce continues.
  • The subsidies fail to take into consideration either the specific regional characteristics of farming activity, nor the contribution of farmers to the production of public goods. 
  • The payments disproportionately benefit large landowners (who are more likely to be relatively wealthy) while the majority of farmers receive very small amounts of aid. 
  • There is no option to differentiate payments within member states to take into account the agricultural potential of regions or environmental criteria. In other words, those who say the CAP in its current form is the best tool for delivering 'food security' or environmental objectives (including bio-diversity) don't know what they're talking about.
  • The Commission has not analysed the effects of SAPS aid on the restructuring of the farming sector - a huge 'blind spot' given that modernising agriculture is one of the stated objectives of the CAP, and given that by giving people income support irrespective of the economic activity their engaged in (if any) is usually an active disincentive for reform. 
  • The Commission has also not yet analysed the effects of the subsidies on land prices. Again a massive blind spot given that the regime is effectively subsidising landowners. 
So in other words, the single farm payment is a ill-targeted subsidy with no clear links to either the delivery of public goods or economic reform. In today's economic climate, to maintain such a fundamentally irrational policy must be considered something of an accomplishment.

What should we have instead? As we argue in our dedicated report on this issue, there could be a broad rationale for having a publicly subsidised system for delivering public goods in the countryside such as bio-diversity. One way of achieving something at least remotely sensible, would be for the CAP to be slimmed down (we proposed a 30% to the direct subsidies which would have saved over €12bn this year) and refocused to deliver a range of environmental benefit through a system of transferable agri-allowances (if intrigued, check out the full study).

But the current system just has to go. 

Wednesday, November 28, 2012

Buying back Greece: another ad hoc deal or a step towards a solution?

Early on Tuesday morning the eurozone and the IMF reached an agreement which has been widely billed as their most comprehensive package to aid Greece. Now that the dust has settled somewhat, Open Europe has published a new flash analysis assessing the key components of the deal.

For all the talk and all the figures flying around there is still only one that really matters – 124% debt to GDP ratio in 2020, clearly this is not sustainable. Further measures will be needed and the ad hoc nature of this deal, particularly the way it skirts the big decisions, suggests that fears over a ‘Grexit’ will return as soon as Greece begins missing its targets once again.

Although reaching some deal was better than nothing, there are still significant doubts over the deal. The mixture of measures do provide some short term relief but in most cases fail to solve any of Greece's real solvency problems. The policy with the most unanswered questions is probably the most important one - the debt buy back.  A key question is: who actually owns Greek debt now? Below we break down the shares of Greek debt (click to enlarge):

We expect that the only bonds actually eligible for the buyback would be those held by foreign financial institutions (€30bn). However many of these bondholders may be reluctant to take part for a multitude of reasons.

See here for the full analysis.

Tuesday, November 27, 2012

Out of touch or totally in tune? Monti wants an in/out referendum in the UK

In an interview on Italian TV on his new book, 'Democracy in Europe', co-authored together with French MEP Sylvie Goulard, Italian Prime Minister Mario Monti was asked by the host whether Europe has "a British problem".

Monti replied:
"Britain rather considers it a 'Europe problem' [Monti laughs, but no-one else in the studio seems to get the sarcasm]. Yes, there is a British problem… [but] I’m one of those who says that Britain has to be kept in the European Union."
Monti went on to say,
"It is good for Britain to stay in the EU and it is good for the EU that Britain stays in. The euro is a different thing. I’m not sure that, at the moment, it would be good for Britain to have the euro and for the eurozone to have Britain in. But there are aspects of European life that go beyond the euro. The single market, foreign policy, defence policy (one day)…The British can, however, be rather frustrating when they seek, as a condition to stay aboard this big European ship, specific exemptions, specific derogations that would ultimately be equivalent to opening holes in the ship and making it harder to navigate, not to say sink." 
"Now, there are some in Europe who would, after all, feel relieved if Britain were not in. I think some French belong to this category. I am convinced that a compromise with the British has to be sought and, above all, it is necessary that, one day – and I spoke about this with David Cameron last week – the British ask their electorate not, ‘Do you agree with this further change that other [EU] countries want to make’, but ask the fundamental question, ‘Do you want [your country] to remain in the EU?’ I’m sure that, at that point, faced with such an important set of choices - banking interests, financial interests, industrial interests - they [British voters] would immediately say, ‘Yes, please’."
So Monti has waded into the British referendum debate, effectively calling for an in/out choice. It is perhaps a  bit ironic that an unelected head of an unelected technocratic government chose to comment so explicitly on how other democratic countries ought to involve voters in key decisions. We'll leave it up to you to decide whether Monti is completely out of the touch with the UK debate or totally on top of it when he calls for a future British referendum on the EU to be a question of "all or nothing"....

Monday, November 26, 2012

Insanity is doing the same thing over and over again, but expecting different results...

Following the collapse of talks on the draft 2013 EU budget (this was prior to last week's talks on the long-term EU budget), the European Commission was sent back to the drawing board and asked to come up with a new proposal. The new draft has been published today and...there is a rather strong sense of déjà vu - it is essentially the same proposal EU member states and MEPs could not agree on two weeks ago.

This is the table comparing the two drafts (click to enlarge):

CA = Commitment Appropriations (the maximum amount of money allocated to each heading)
PA = Payment Appropriations (the maximum amount of money which is actually going to be disbursed)

So, basically, the total reduction in payments proposed by the European Commission is less than €127 million. The justification is the usual one: EU member states have committed to a series of projects which are now about to be finalised - and there are outstanding bills to be paid. But, if you are a government under an EU-mandated austerity programme - or a a household - you are forced to prioritise and find savings when there is not enough money in the pot.

The Catalans have voted: for what exactly?

It does not happen very often, but the final result of yesterday's Catalan elections was almost completely unpredicted by polling. Artur Mas (in the picture) and his centre-right Convergència i Unió (CiU) party were always going to win - and they did so. However, according to most opinion polls, Mas was, at worst, going to consolidate the 62 seats that his party currently holds in the Catalan parliament - but he failed to do so, and by a wide margin.

CiU only secured 50 seats - 18 short of the 68 needed to command an absolute majority. Needless to say, Spanish Prime Minister Mariano Rajoy's party has immediately described the result as a bofetada (a "slap in the face") to Artur Mas - claiming he has failed in his attempt to lead Catalonia towards independence.

So have the Catalans suddenly given up on independence? Not quite. The exploit of the left-wing independentist, anti-austerity and anti-monarchic Esquerra Republicana de Catalunya (ERC, Catalan Republican Left) won them 21 seats - eleven more than in the previous elections. Therefore, Mas could certainly try to push ahead with his plans for a referendum on Catalonia's independence with the support of ERC. 71 votes from a total of 135 seats in the Catalan parliament (without counting the smaller pro-independence parties) is not the "exceptional sovereignist majority" Mas hoped for - but is a majority nonetheless.

This is exactly what the Catalan President noted in his first remarks after the election results were made official yesterday night. He said,
Those who want to abort the [sovereignist] process should take into account that…the sum of political forces in favour of the [Catalans’] right to decide is very much a majority in the parliament.
However, CiU and ERC are hardly natural allies or the makings of a stable and durable coalition. In particular, the two parties clearly do not see eye-to-eye on the need for Catalonia to continue with fiscal consolidation. At this stage, it is difficult to predict how things will evolve within the next few weeks or months. But the following should be kept in mind:
  • Under the Spanish Constitution (see here, Article 149.1), any referendum needs to be authorised by the central government. During the electoral campaign, Artur Mas has repeatedly suggested that he would get around the problem by holding such a referendum within an 'alternative' legal framework - i.e. a new Catalan law which would provide for the necessary legal base. However, this would be unlikely to stop the Spanish central government from taking the referendum to the Constitutional Court to invalidate it.
  • Great uncertainty remains over how Catalonia would declare its independence in practice - not least because an amicable divorce seems to be out of the question for Rajoy and his cabinet. In any case, it would be wrong to see Catalan independence as a short-term prospect.
  • Finally, and most importantly, an independent Catalonia would find itself out of the EU. Many have argued that the EU would have a strong interest in letting Spain's economic powerhouse back in as quickly as possible. A fair point, but under the current EU Treaties, Catalonia's accession would need to be endorsed by all member states - including Spain. This is arguably the biggest stumbling block for Artur Mas's hope of making Catalonia "a normal nation in Europe". Crucially, previous opinion polls have showed that the prospect of continued EU membership would be a big factor in a hypothetical referendum on independence.
Everything else, at this stage, is far from clear - especially given that the new Catalan government is not yet in place, and forming one may not be the easiest of tasks.  

Friday, November 23, 2012

As much of a 'Nein' as a 'No' - Don’t blame Cameron for the break-down in EU budget talks

On his Telegraph blog Open Europe's Mats Persson analyses the breakdown of EU budget talks, see below for the full piece:
As predicted, the talks over the EU’s long-term budget have broken down. What does this mean? In truth is, not that much. Postponing a decision was always the most likely outcome. A new deal will now have to wait until after the December EU summit when leaders will try to hammer out the details involved in a European banking union. On substance, this is a far bigger issue than the EU budget, as it’s breaking new ground and links to the stability of the euro. The EU budget is a maddening legacy issue.

Had Cameron been forced to pull the veto this time around, it would have been a completely different matter.

There will be those on all sides tempted to blame David Cameron for the breakdown in the talks. This is simplistic. As Angela Merkel pointed out at her press conference just now, there were two main groups who disagree — net contributors and net recipients. Within these groups, as Open Europe has consistently highlighted, there are a series of disagreements. From the Danes who want a rebate to Malta who want to be treated as a ‘special’ case. All positions matter since every country has a veto. In total, eleven countries had explicitly threatened to veto the budget in case they couldn’t secure a favourable deal for themselves. Interestingly, France and Germany struggled to reach a common position, with Berlin leaning towards London on several points, including on cutting the EU’s admin spending. So forget the 26 vs. 1 narrative.

Moving forward, David Cameron remains in a very tricky, but far from impossible, position. His negotiation mandate is exceptionally narrow following the Parliamentary vote in which a majority of MPs backed a cut in the EU budget, rather than the freeze Cameron has called for. He also suffers from a major communication error committed early on in the talks. The British Government decided to use the amount of cash that was actually paid out from the EU budget in 2011, €886bn, as its “baseline”. When this figure is extrapolated to the entire seven-year EU budget period, it creates an artificially low figure – far below the “appropriation ceilings” (the maximum amount of cash that can be paid out rather than the actual cash paid out) — meaning that Cameron has to fight seriously hard to live up to the high threshold for a “freeze” that he had set for himself. But if the Government is using the same measure as everyone else – payments appropriations over the full seven years – it is now on way to actually achieve a freeze or even a cut, when compared to the full 2007-2013 EU budget period. So budget period to budget period, the Government is in a pretty good position.

David Cameron had a very solid press conference after the summit – he sounded plausible (which hasn’t always been the case) – but to date, the Government’s communication strategy around the EU budget talks has been pretty appalling. It’s been very difficult to figure out what, exactly, the UK government actually was pushing for, and by focussing on a 2011 real terms payments freeze it may have been a bit too smart for its own good.

The real tragedy with these talks is that no one is actually focussing on the substance of the EU budget. As we have shown – comprehensively – the EU budget is an economic anomaly. It’s not a huge amount of money, but if targeted properly – rather than wasted on economically inactive landowers or recycling regeneration cash – it would make a real difference.

 It speaks volumes about the current state of the EU that this budget remains unchanged. That’s not only Cameron’s problem, but also the rest of Europe’s problem.

Open Europe publishes (and analyses) leaked draft of Van Rompuy's new EU budget proposal

We’ve got our hands on a leaked copy of the latest HermanVan Rompuy (HvR) proposal for the EU budget (see here for the full doc). The headline spending figure remains broadly unchanged in the new proposal, standing at €1,014bn (a €4bn increase), but more cash is spent on farm subsidies and structural funds, in a move designed to appease France, Poland, Italy and Spain.

(The figures here includes off budget items, if they are discounted the second proposal is actuall a decrease, from €973bn to €972bn. This is mostly due to items which weren't off budget in the original proposal, being off budget in the second version).

No figure is given for payments appropriations – the figure that the UK government is targeting – but given that this figure has widely been cited to be €940bn, it’s likely that it’ll have to come down more if acceptable to the UK (with the government's initial proposal at €886bn).

Also, just like with the previous draft, the latest HvR proposal foresees cuts to the UK rebate – which is a non-starter for Britain.  As a refresher (from our recent flash analysis):
“The proposal also includes an adjustment in the way in which the UK rebate is calculated. This could result in the UK rebate falling by as much as 11% or €3.5bn across the next budget period, solely due to this adjustment.

The plan also suggests that ‘corrections’ such as the UK rebate will be “fully financed by all member states”. It’s not entirely clear what this means, but it does suggest that the UK could actually be responsible for funding part of its own rebate. If this were the case then the rebate could be reduced by a further €3.316bn, cutting the rebate by a further 11.5%, and 21% (€6.8bn) from its original amount.”
The increased spending on CAP and Cohesion moves further away from the spending split which many in the UK would like to see (more growth focused) while although the headline figure has not increased it is still probably slightly too high. See table below for the full break down (click to enlarge):

So, despite talk of progress last night, it still seems that, from a UK perspective (but also likely a Swedish, Dutch and German one) there are some significant divisions.

Looking to the New Year?

With trouble flaring up in Greece once more and the backstop of the ECB’s bond-buying (OMT) in place, Spain has slipped off the radar slightly. It now seems likely that any request for a sovereign bailout (of one form or another) will be pushed back until the New Year.

However, interestingly, Spain returned to the debt markets this week despite having its funding costs covered this year. It successfully sold almost €5bn worth of short-term debt on Tuesday and almost €3.9bn of medium and long-term debt yesterday.

This could mean many things, not least that the Spanish government is concerned about its cash position or the potential for unexpected costs (a regional or bank bailout for example), but we’re willing to give Spain the benefit of the doubt and see it as prudent planning to get a head start in covering its funding needs next year. This comes as somewhat of a relief given that gross Spanish funding needs could run between €150bn and €200bn next year.

On a separate, and slightly less positive note, the European Commission has, in a working document, questioned why the Spanish government has, in substance, refrained from intervening in those Spanish regions which are "clearly at risk of missing their fiscal targets in 2012" - despite legislating earlier this year to give itself such power? It is an interesting question, we would hazard a guess that the Spanish government is not ready to face the political consequences of such an action.

We can’t exactly blame them on this front but it raises the question of where their threshold is and what the repercussion of such an action would be.

As per usual from Spain then, a bit of a mixed bag, but at least it seems to be planning for next year. Now if only it took a longer term approach to its banking sector and labour market reforms…

Thursday, November 22, 2012

Meet the EU budget 'veto team'

This EU budget stuff can come across as pretty dull and confusing. To lighten things up a bit, we will turn to the universal language of football. So meet the EU budget 'Veto Team' - the eleven EU leaders that so far have threatened to veto the EU budget unless they get a better deal. Needless to say, given that this is its first outing, the eleven-man team is far from a cohesive unit - with lots of big egos and players who play for themselves.

(Click to enlarge the picture)

CF: David Cameron leads the line, ready to strike and seen as the most likely to pull the trigger on any veto.

RW: Swedish Prime Minister Fredrik Reinfeldt at right winger hugging the line (sticking to his guns), happy to put in a shift for the team and more likely to offer an assist/support for Cameron than to deliver the final blow himself.

AM: French President François Hollande is the mercurial trickster playing between the lines but not quite sure of his role or his aims. Ultimately a selfish player (as are many of the others) but whose own personal gain could ultimately be detrimental to the rest of the team.

DM: Italian Prime Minister Mario Monti is playing the stoic holding role, refusing to budge and occasionally gesticulating wildly at the referee, although never actually getting into the danger zone at the forefront of the action. More likely to break up play and provide a stumbling block than deliver a knockout blow to the opposition. Unlike the rest of the team, not here on merit (elected) but parachuted in by the powers above.

LW: Portuguese Prime Minister Pedro Passos Coelho takes on the Cristiano Ronaldo role as a marauding left winger and not just because of the nationality. His red line that Herman Van Rompuy's proposal is unacceptable makes him more of a threat than many expected. Under pressure to perform from his home fans (electorate) he needs to put in a big showing – the question remains though whether he will rise to the challenge or crumble under the pressure.

MC: Dutch Prime Minister Mark Rutte is playing the 'box-to-box midfielder' role, akin to the days of Johan Cruyff's 'total football'. Usually more inclined to side with Germany (the opposition), Rutte finds himself dragged end-to-end with action not quite sure where he should be or where he is best suited. One things for sure, his hometown team (the VVD party) would love to see him score.

LB: Belgian Prime Minister Elio Di Rupo, naturally inclined to the left, find himself at left back. His demands are relatively minor and he’s not a regular in this team (usually part of the core EU group whose views align closely). He’ll put up a fight for a bit but he’s not a star player in this game.

CB: The towering centre-back, Danish Prime Minister Helle Thorning-Schmidt provides a solid spine to the team. Not one of the more flashy players but they know their job and what they want out of it (a clean sheet). Unlikely to score (pull the veto) but will definitely provide a blocker against any increases in the budget.

CB: Austrian Chancellor Werner Faymann is another unfamiliar member of the team. Stuck in at centre back because of its experience in the eurozone crisis and playing a key blocking role in minimising the liabilities. Unfortunately, his aims are different in this game and, as with Hollande, he may end up scoring an own goal (getting more spending in the budget).

RB: Romanian President Traian Basescu, at right back, is there as a late replacement and now a token entry. The previous incumbent (Romanian Prime Minister Victor Ponta) looked set for an interesting game, but after the substitution this role is unlikely to provide much action.

GK: Latvian Prime Minister Valdis Dombrovskis is in goal because, well, the smallest kid always gets stuck with the worst job.

UK would not be ‘biggest loser’ of EU budget failure

We have a letter in the FT today pointing out that the UK would not be the biggest loser if there is no positive outcome from the talks on the EU's long term budget - a fact we have noted at length in two recent flash analyses. We have also highlighted in recent blogs that the UK is far from alone in threatening a veto.

In an article a couple of days ago the FT suggested that if there was no deal on the long term budget the UK would be the biggest loser since the current budget framework would rollover (increasing for inflation), thereby taking it above the UK government's demands and increasing the UK's contribution.

See below for our full response letter:


You say that “if there is no agreement” in on-going talks over the next long-term EU budget, the UK could become the “biggest loser” (“EUbudget: the trillion-euro split”, Analysis, November 21). This is incorrect. It is true that “the 2013 budget ceiling would be repeated – plus inflation – for each successive year” and that this would be higher than the freeze the UK has called for. However, this scenario would be far worse for other countries than for Britain.

First, newer member states would probably lose out on a large share of the cash that is due to be allocated to them in the new budget period. Second, unlike the UK’s rebate, all other correction mechanisms – such as the Swedish or Dutch – expire in 2013 and would need to be renegotiated under unanimity rule. Finally, and most importantly, the UK’s net contribution under a rollover is about €3bn higher than under the current proposal by European Council president Herman Van Rompuy. However, the Van Rompuy proposal also includes a reduction in the UK rebate of between €3.5bn and €7bn, meaning the UK contribution would overall be lower under a rollover.

Wednesday, November 21, 2012

The confusion of EU budget maths

Confused by the various figures flying around in the EU budget talks? When is a freeze a freeze and not an increase etc? Don’t feel bad, everyone is confused. There are a number of ways to calculate the increase or otherwise in the EU budget, depending on whether one looks at:
  • payments or commitments
  • net contributions before or after rebate
  • gross contributions before or after rebate
  • on-budget items only or also EU spending outside the main budget
  • Current prices or constant prices 
In other words, enough to do your head in. Heading into tomorrow’s negotiations on the EU budget there are essentially two crucial elements to take into account when considering whether Cameron has managed to deliver what he has promised (a real-terms payments freeze): the level of “payment appropriations ceilings” versus “commitment appropriations ceilings”; and share of EU spending covered by UK’s rebate.
The first point is tricky because the UK Government has set its stall out using different measurements to everyone else.

Every annual EU budget includes a figure for ‘commitments’ (which are essentially ‘promises to pay’ or funds that can be earmarked that year) and ‘payments’ (the level of money actually paid out in the given year). The long-term budget on the other hand, which is being discussed tomorrow, includes ceilings that limit the maximum level of commitments and payments that can be made in the years 2014-2020, with payments always lower than commitments.

Now, all the plans on the table at the moment, except the UK’s, compare proposed commitment ceilings for 2014-2020 to the previous long term budget’s commitment ceilings for 2007-13. The UK has taken the level of payments from the 2011 budget (i.e. the money actually spent that year) and, after scaling the figure up to cover the full seven years, used this as its baseline. This helps explain the very large gap in the UK’s proposal compared to the others. Using everyone else’s baseline (2007-13 ceilings), the UK proposal looks a lot more like a real terms cut than a freeze.

Reports overnight suggested that the UK was ready to negotiate a deal based on the Herman van Rompuy (HvR) proposal – on the surface this looks like a significant U-turn given that the UK’s proposal totals around €886bn in payments compared to €1011bn in commitments under the HvR plan. However, this is comparing payments with commitments. New reports suggest that the new version of the HvR proposal includes a payments ceiling of around €938bn, significantly closer to the UK’s position and a slight real terms cut on the current payments ceiling (€4bn). This then is the figure to compare. This figure is likely to have to come down further to be accepted by the UK. But, although it wouldn’t be ideal, David Cameron might be able to sell this as a ‘cut’ or ‘freeze’ at home, because on everyone else’s terms it would be.

The main stumbling block with the HvR proposal falls under the second issue – the rebate. Currently, the plan would change the way the rebate is calculated, removing the UK’s compensation for ‘rural development’ spending in the new member states and requiring the rebate to be funded by all member states (including the UK). We estimate that this could cost the UK between €3.5bn and €7bn over the seven year period – this clearly makes it unacceptable to Cameron, who has pledged to defend the rebate. However, this proposal to change the rebate would appear to be a straw man to knock down (a domestic win for Cameron).

This is because, as we noted a few weeks back – featured by Newsnight - the UK rebate is already set to fall by a similar amount, simply by virtue of the way money is likely to be allocated in future and the way the rebate works. More money is set to go to the newer (poorer) member states and this means there will be less spending on which the UK receives a rebate. This means that the UK net contribution to the EU budget could rise even if there is a freeze or a small cut in the budget. This is unavoidable and much a result of previous rebate negotiations under Tony Blair.

Overall, the UK could end up with a deal where its net contribution increases (due to a fall in the rebate) and the overall budget is above its desired target. But, this is not as bad a deal as it might appear and could still represent a real terms cut in the budget (on all the other member states’ and the European Commission’s baseline). Of course a lot could still happen in the coming days.

That said, the EU budget remains an anomaly and an insult too all economic common sense. We would still much have preferred the UK to push for wider reform of the EU budget in terms of content as well as size, especially since (as our recent blog showed) plenty of other countries were upset at the potential spending increase.  The simple fact that we need to explain all of this speaks volumes about how the UK Government has communicated its strategy. It failed to properly express what it’s position was and why, which has probably made it more difficult to explain its position to both its EU partners and the general public alike. This could cost the Government when it comes home with a deal. 

The EU budget 'veto count': and then there were ten...

Here's an update of Open Europe's 'veto count': ten EU member states (UK, Denmark, Sweden, Italy, France, Portugal, Latvia, The Netherlands, Austria and Romania) have now explicitly threatened to veto the 2014-2020 EU budget. Several other countries are also unhappy with all or part of Herman Van Rompuy's compromise proposal (see our latest flash analysis for further details).

This is what changed since we made our first 'veto count':

Italy and Portugal have both used the 'V' word for the first time. Interestingly, Italy has also suggested that it could seek a UK-style rebate to avoid its net contribution to the EU budget skyrocketing.

Latvia has also threatened to wield its veto. Latvian Prime Minister Valdis Dombrovskis said his country is not happy with the cuts to agricultural subsidies and cohesion policy proposed by Van Rompuy.

In Romania, incidentally, it looks as if EU budget talks have triggered another row between President Traian Basescu and Prime Minister Victor Ponta. The latter said he was ready to veto the budget, but President Basescu said this morning that "Romania's interest is to negotiate, not to brandish the threat of using its veto right." Given that Ponta is the one who usually attends EU summits, we consider Romania to be in the veto camp.

So over one-third of EU member states has therefore threatened to veto the next long-term EU budget so far. EU leaders could be looking at a long weekend...

Britain is not about to get completely stuffed in Europe

On his Telegraph blog, Mats Persson argues:

Take a deep breath. Britain is not about to get completely stuffed in Europe.

The FT ran a story the other day claiming that the EU could circumvent the UK’s veto over the EU’s next long-term budget (2014 to 2020) , effectively turning David Cameron into a spectator in the talks and forced to accept spending increases. Stories like these fuel speculation that “Brixit” – the UK leaving the EU – is just around the corner.

But how much of this is actually substance as opposed to noise? The FT story was pretty implausible – ‘circumventing’ the UK’s veto will be very difficult. In case of no agreement before the end of 2013, EU officials could move to roll over the 2013 EU spending ceilings adjusted to inflation with up to 55 individual spending items decided by Qualified Majority Voting (QMV). This would be extremely messy. There's no way 26 countries would agree amongst themselves to take a common position against Britain on 50+ spending areas – at least eight countries have already threatened to veto the EU budget for different reasons.

But let’s do some war-gaming around EU events this autumn, to see how bad things really are for Cameron.
EU leaders will discuss the long-term EU budget this week, starting tomorrow. There are effectively three possible outcomes from the Brussels summit: a new veto moment for Cameron, a deal or postponing the decision. Though all options are on the table – and a deal this weekend isn't impossible – the latter remains the most likely.

Following the recent vote in British Parliament, in which a majority of MPs voted for a cut to EU spending rather than a freeze, Cameron can hardly accept the proposals for an increase that are floating around.
But forcing Cameron to veto the EU budget this week could trigger a “perfect” storm not only for Britain, but also the EU as a whole, in which everyone would lose. A new veto would really sour relations between the UK and Europe, and any attempt to try to press ahead without the UK would be met with fury in Westminster as it would effectively involve taxation without representation. Agreement on an EU “banking union” – the far bigger fish to fry as it links with the stability of the euro – would then be much more difficult to reach at the EU December summit, when leaders will hammer out those details.

The UK also has a veto over the banking union. Though it’s currently broadly supportive, should the UK be singled out in EU budget talks, the banking union will be far more difficult to manage in Westminster as every front page in the land will be splashed with “EU stitch-up” headlines. Cameron will come under pressure to pull a second veto over banking union to take back control over events.

EU officials say they have a familiar back-up plan should this happen: ignore Britain. The EU, they say, could press ahead with banking union under so-called “enhanced cooperation”, allowing a limited number of member states to pursue more integration, if not possible at the level of all 27.  But this would trigger a massive crisis as the UK would, for all practical purposes, find itself “not in the euro but run by the euro” – London’s worst nightmare. Legal challenges and massive uncertainty for the eurozone would follow. Britain would also be half-way through the exit door.

Far-fetched? Most certainly. It could happen. But Berlin and Brussels will get cold feet long before it gets to that. The legal foundations of trying to rewrite the role of the ECB, turning it into a bank supervisor, using enhanced cooperation would be so weak that Angela Merkel’s lawyers could well suffer a nervous break-down.

And this also shows that beyond the huffing and puffing – and the indulgence of “isolation” stories – it’s in everyone’s interest to reach a deal. But that’s only with regards to events this autumn of course. There will be plenty more fraught moments to come.

Tuesday, November 20, 2012

Trying to find two more years for Greece

Ahead of today’s meeting of eurozone finance ministers we thought we’d (finally) get round to posting some of our thoughts on the last week’s leaked Troika report on Greece. The report, as may be expected, left much to be desired – and we’re not just talking about the copious glaring gaps where the eurozone and the IMF could not agree (the missing new debt sustainability analysis being the more prominent). The firefighters are fighting amongst themselves as one paper put it.

The report suggests that the cost of providing Greece with a two year bailout extension will be €32.6bn – very much in line with our estimates of between €28.5bn and €39bn. Interestingly, up to €20.3bn of this total is due broader problems with the original bailout programme, with the troika suggesting only €12.4bn will specifically be for the fiscal adjustment. This may not seem like it matters much but it highlights that the financing issues don’t just come from fiscal issues but also low growth, increasing arrears, banking sector problems and more.

Below we list a few other concerns from the report:
- The unemployment figures, as in the recent Greek budget, seem to be hopeless optimistic – potentially more so than before, since the Troika see unemployment in 2014-2016 being 0.4% below where the Greek government does. Elstat (Greek Statistics Agency) put unemployment at 25.4% at the end of August, while the Troika expects it to be 22.4% by the end of the year. A 3% drop in unemployment in a few months? That seems impossible anywhere but particularly in the current Greek economy.

- The report expresses some deep concerns over the banking sector not least the “plummeting” deposits and the likely need to run down capital buffers due to significant levels of bad loans. However, it still concludes current levels of recapitalisation should be sufficient – we’re sceptical.

- Despite, finally cutting defence spending, Greece still spends the third most (as % of GDP) in the EU. This continues to seem an obvious place to make savings, particular with NATO still going strong.

- The collapse in real investment of 40% since 2009 is staggering if not surprising, yet the forecasts for investment both in the troika and budget reports only looks ever more optimistic because of it.

- Government arrears continue to mount up, topping €8bn now. Despite presenting a significant challenge to wind down in the near future, these could also represent a drag on the domestic economy since most of the money is owned to domestic firms. 
That is to name but a few from an incomplete report – i.e. there are plenty more to come.

As for the outcome of today’s meeting, we have low expectations as usual. The target is for a political agreement on the releasing the next two tranches of Greek funds (worth €44bn). This doesn’t sound much of a stretch but it will require confirming Greece has completed the necessary ‘prior actions’, as it claims, while the IMF is hesitant to release any more funds until it has settled on a plan which sticks to its view of Greek debt sustainability. The final part will be tricky with the IMF and the eurozone still seemingly someway apart on what they see as sustainable (despite the two of them also being someway apart from the rest of the economic and financial professions).

A deal on how to fund the two year extension in the Greek bailout will likely need another meeting, while the release of funds still has to withstand the hazardous approval process of the German, Dutch and Finnish parliaments.

Expect the debate over the issues above and more to dominate for another few weeks.