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Friday, November 22, 2013

Eurozone reform contracts take shape - and they include "fiscal transfers"

As we have predicted numerous times - as recently as in our previous blog post - ‘reform contracts’ in the eurozone could well become the next thing. As a recap, these are agreements where one country commits to a series of structural reforms in exchange for low cost loans, or other form of help, to aid its economy. As we argued back in September - when it was unclear whether the idea would make a comeback - it's one of the  politically more feasible options for Germany as it involves more control and less cash.

Well, Reuters have now got their hands on the latest draft of the plans for these contracts and have published them in full here. The idea now seems to be firmly on the agenda, which is not the same to say it'll actually happen.

Below are the key points of the plans:
  • The contracts are seen as a supplementary part of the ‘European Semester’ – the new system of economic governance. They will build on tools such as the macroeconomic surveillance and budgetary oversight, which we have already covered in detail. The contracts are targeted at those countries not making adjustments under the other procedures.
  • They are designed to promote “ownership” of reform and “home grown” policies (which lines up with Merkel's comments from yesterday). There is, of course, a tension here, given that by definition they are part of a system of increasing economic oversight and some would say a loss of control of economic policy. As Eurogroup Chief Jeroen Dijsselbloem suggested yesterday, if these countries aren’t pushing these reforms, slightly cheaper loans are unlikely to be the deciding factors in pushing them to do so.
  • Further to the above point, the text does stress that the policies will be drawn up by the domestic authorities and will be renegotiable (unlike the bailouts or other parts of the governance system which are more set in stone).That said, they will come with significant “monitoring” – which, to us, evokes the feeling of the EU/IMF/ECB Troika trips to bailout countries.
  • The loans will involve “limited fiscal transfers across countries”, the large majority of which would come through the lower interest rate on loans compared to the borrowing countries usual market rate. The open admittance of fiscal transfers has slipped into the draft, this sort of open admission is rare in the eurozone crisis, but given that the contracts are an explicit trade off, it is not entirely surprising (again, as we've argued).
  • “The specific amount of financing would not be linked to the direct cost of reforms”. Instead it will be used more generally as an incentive to reform and aid any parts of the economy that need it or to help relieve funding pressure generally. This makes some sense since simply ‘paying’ for reforms seems rather circular and dictatorial. However, making sure the level of reform demanded matches up to the loan size will be very tricky.
So this is something that could fly with the Germans, politically, but how much difference will that make in practice? There are already numerous platforms for reform – bailout programmes, precautionary credit lines, macroeconomic surveillance and budgetary oversight (as well as good old political pressure).

In the end it all comes down to the money. How much will be available and at what price? These questions are yet to be answered, but as with much in the crisis, the likelihood of a muddy compromise looms large.


Jesper said...

It makes me think of the old Swedish folktale about the 'Master Tailor'.

The end result in the tale was: Nothing.
However, maybe the effort by itself can be seen as a very costly Keynesian stimuli of the economy for academics?

Link to (one version of) the tale (in Swedish):
(Please note: Automated translators makes a horrible job of translating it)

Rollo said...

If the Eurozone was one nation, no doubt the richer areas would contribute towards the poorer areas; but there is no doubt who would control the budget, the economy, the governance of those areas. Is that what people want?

Patrick Barron said...

The people of Europe will be taxed and expropriated against their will. If the nations needing structural reform actually submitted a workable plan, private capital would flow to them. But we all know that there is no enforcement of any plan, whether workable on paper or not. The only "plan" for the nations needing structural reform is to actually implement the reforms first, thus proving to the private market that these nations are good credit risks. The EU is trying to put the cart before the horse.

jon livesey said...

I noticed from the terms the troika is negotiating with Greece that one demand was to suspend the current ban on foreclosing on non-current mortgages.

Now who thinks this is a good idea? With a poverty rate of 36% and a high percentage of empty houses already, this can't benefit the Greek people.

And it won't benefit the Banks either. Banks don't want to own unsalable empty houses. That's why they often try to work with borrowers to "repair" a mortgage.

The Troika baffle me. They often seem to make demands simply to increase the pain the periphery is experiencing.