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

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

On 'growth' versus 'austerity'

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

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

On national responsibility vs 'European Solidarity'

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

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

On meeting EU targets

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

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

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

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

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

Full circle in Cyprus

Update 13:15 22/03/2013:

Thinking about the plan in more detail, it occurred to us that this may amount to trying to burn the larger depositors twice. As we noted in today's press summary, the plan essentially is to move all the bad assets to a bad bank, along with the large uninsured depositors (€100,000+). These assets would then be wound down or sold off at a large discount with the depositors footing the bill (and taking losses of 20% - 40%). This, along with the merging of Bank of Cyprus and the good bank, is how the recapitalisation costs will be reduced by €2.3bn.

So, the large depositors will take significant losses here and yet may still face a large deposit tax as well? That seems to be pushing the boundaries to us, although it is not impossible. Cyprus would not recover as destination for foreign investment for some time. One way to structure this could be for the tax only to be applied to depositors above €500,000 (as we suggest below) and the bad bank to apply to all uninsured deposits. Obviously, the bad bank scheme also only applies to Laiki bank, but as the second largest Cypriot bank it is still likely to account for a large amount of big deposits.

Still this could see larger depositors taking up to 50% hits in some cases. We can't imagine Moscow would take that one lying down, especially given comments earlier in the week...

****************** Original Post *********************

It now seems we have come all the way back round to the deposit levy as a solution in Cyprus. Overnight, the EU/IMF/ECB Troika rejected the plans for a Cypriot solidarity fund, particularly one based on pension assets and gas reserve revenues (which German Chancellor Angela Merkel specifically spoke out against).

The bank restructuring plan does seem to be holding water for now, so this has at least reduced the money Cyprus needs to raise by €2.3bn. Unfortunately, though, that still leaves €3.5bn to be found. As we noted a week ago, there are few options for doing it – and it slightly worries us that Cyprus and the eurozone are only just realising this.

Inevitably, that has led us back to a deposit levy. Fortunately, with the amount of money needed reduced, a new version can focus on larger depositors – which is reportedly what was originally proposed by the Troika last week. Barclays has a useful table on the breakdown of deposits (via @FGoria):

Going from these figures, a 12.2% tax on deposits above €500,000 would yield the €3.5bn necessary. A 9.46% tax would also be sufficient if applied to all depositors over €100,000.

Either of these options would probably be acceptable to the Cypriot parliament. Sources suggest that the Democratic Party (DIKO, Cypriot President Anastasiades's junior coalition partner) has indicated its support for such proposals, which would bring the government up to 28 votes – so potentially needing only one more.

There are plenty of pitfalls left, but we may get a vote this evening. That said, noises from the Troika earlier suggested they could take the weekend to review the bank restructuring deal.

As has been the case for the whole of this week, uncertainty seems to be the order of the day. One thing we can take away is that a deal may be inching closer…

How might a revised Cypriot bailout deal look?

Update 11:00 GMT 18/03/2013

Sources told Spanish news agency EFE that the Cypriot government and the Troika have agreed to cut the levy on depositors with less than €100,000 to 3% and and increased the levy on those with more than that to 12.5%, but we haven't seen this confirmed by anyone else so treat with care.

Update 09:15 GMT 18/03/2013:

The WSJ is reporting that Cyprus could seek a further division amongst uninsured depositors (which @MatinaStevis tweeted already yesterday). According to the paper, the Cypriot government is pushing for 3% on below €100,000, 10% on between €100,000 to €500,000 and 15% on €500,000+. There are no clear figures on how much each individual levy will raise, although Germany is said to be open to the idea as long as the total of €5.8bn remains.

The Cypriot parliament will vote on the deal at 2pm GMT, with eurozone finance ministers due to have a teleconference at some point later this afternoon.

Original post

As we reported yesterday, the Cypriot government is now scrambling to renegotiate the deal which has created such an outcry in Cyprus. Germany and the IMF will not budge on the headline figure or that the money must come from a deposit levy (the only option to raise this sort of cash anyway), however, they do not mind which depositors pay it or at what rates.

This has led to suggestions that the rates could be adjusted to increase the cost on large uninsured depositors and reduce the impact on smaller insured depositors – this would probably be both legally and politically more acceptable.

So how could it be structured? Well, Cyprus has around €30bn in insured deposits below €100,000 and €38bn of uninsured deposits above €100,000. See table below for potential structures (click to enlarge):

Option 1 seems to be what is currently under discussion. Option 2 might be politically popular, although the impact on business and investment could be significant. One thing that is clear, as we have repeated over the weekend, is that this deal remains in flux.

Is there any chance Cyprus could secure a better deal?

UPDATE 22:00 

According to Reuters, German Finance Minister  Wolfgang Schäuble claimed today that it was indeed the Cypriot govenrment's  decision to go for smaller depositors - not Germany's. 

Speaking to public broadcaster ARD he said, 

"It was the position of the German government and the International Monetary Fund that we must get a considerable part of the funds that are necessary for restructuring the banks from the banks owners and creditors - that means the investors."

"But we would obviously have respected the deposit guarantee for accounts up to € 100,000...But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people."

 Let the finger-pointing begin...

ORIGINAL POST

As we have pointed out, the bailout deal and deposit tax are still subject to Cypriot parliament approval, which is far from assured but looks likely.

In any case, questions are arising of whether there is scope to adjust the level or structure of the tax, with reports claiming that the Cypriot government is currently in talks with EU partners to revise the deal, possibly shifting a greater share of the burden to larger depositors. This would make the deal far more politically palatable.

Much of the outcry has been against the 6.75% tax on depositors below €100,000 – mostly 'ordinary' Cypriot savers. The perception is that EU leaders and the IMF imposed this on Cyprus. The question is, if the parliament rejected the deal - or with the threat of it rejecting the deal (still unclear whether there will be a majority for it in the Parliament) - could they perhaps push for the 9.9% rate for depositors over €100,000 to be increased, with a corresponding lower share for the lower end depositors? And are there possible progressive arrangements, involving several different depositor 'brackets'?

It is possible, since technical details are still being ironed out (for example if you have €100,000+ will it all be taxed at 9.9% or part at 6.75%). However, the important point to note is that, although Germany was the driving force behind the tax itself, it seems that the Cypriot government played a role in designing it. Mainly, reports suggest that the Cypriot President Nicos Anastasiades was reluctant to return with a double digit tax on higher deposits as this would anger Cypriot businesses and investors as well as scare of foreign investors. In other words, Cyprus worried that this would kill the country's position as an 'offshore' financial centre.

It has of course been reported that Germany and the IMF were pushing for a double digit tax initially – but on whom? Think about the maths for a second. The current structure raises almost €6bn. The max which the Eurozone was trying to cut of the bailout was €7.5bn. So, with €1.4bn in privatisations the target is reached. Logically this must mean the higher rate would have raised the same amount and therefore been applied to fewer depositors. This simple calculation suggests that the negotiations moved from a higher double digit tax on a specific group to a broader lower tax.

In any case, the important point to note is that the structure of the deal and the decision to hit ordinary depositors may not have been entirely a Eurozone one.

Whether the Cypriot government can or will change its position remains to be seen, but all of this suggests there should be some scope for a revised deal, though it would be far from ideal to keep the details unclear when markets open.

Mali and France: about that 'pact of European solidarity'...

It's always interesting to watch rhetoric and negotiation posturing clash with reality.

Following David Cameron's EU speech last week, Najat Vallaud-Belkacem, a French government spokeswoman, insisted that:

"Being a member of the European Union has a number of obligations... The Europe that we believe in is a pact of solidarity and that solidarity applies to all member states".

Yeah, about that "pact of solidarity":

Ministers from the 27 EU member states, plus Norway and Canada, are currently discussing the operation in Mali, with the Canadians seemingly more committed to 'European solidarity' than the Europeans given that they already have special forces on the ground. The Germans are providing cash, two transport planes and possibly some training personnel while Poland is likewise considering participating in the training operations, with a decision due by the end of the day.

Other European powerhouses are still to make their minds up. In other words, we'll see what the great pact of solidarity can deliver for the French in the end...

Does European solidarity have a new champion?

Apparently, Cameron told the BBC the following this afternoon:

"I understand Angela Merkel’s difficulties and her political difficulties because the Germans have run their economy very effectively over many years. But it’s their currency, they need their currency to work, so they need to have guarantees from other parts of the eurozone that they’re putting their house in order, but there has to be solidarity as well."

Solidarity? As long as it doesn't involve Britain itself of course. Not. Smart. Politics.