The Karlsruhe factor, Part IV

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

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

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

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

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

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

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

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

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

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

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

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

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

A great way to run down a bailout fund?

Ahead of the summit today the proposals for the EFSF/ESM to start purchasing sovereign debt began rearing its muddled head again, with some indication that this is actually one of the few things that could be agreed at the summit. We hate to be party poopers but as we have already noted (at length) this is a confused idea and will likely provide little help relief to those countries embroiled in the eurozone crisis. Below we outline some of our key concerns with the plan:

• The capacity will be tested: this role was previously filled by the ECB. Markets know that the ECB can provide an unlimited backstop and will rarely test its resolve in keeping yields down. However the EFSF only has around €250bn left, while the ESM has a lending cap of €500bn (as we have shown though this will also not be fully operational for some time). In any case markets are likely to test the resolve of these funds, meaning they may spend more than is needed and may be less effective than the ECB was. 
• Will deplete the funds of the EFSF/ESM: further to the point above, the money in the bailout funds will be severely depleted reducing the capacity for them to fully backstop countries which may need full bailouts. Particularly a worry if Portugal needs a second bailout, Greece a third and Spain possibly a full one on top of its bank rescue package. 
• Subordination: if ESM purchases bonds other debt of the recipient countries will become junior. This increases market jitters. Would be less of a concern if these purchases solved any of the issues but they only simply delay them at best.
• Secondary market purchases: if the buying is on the secondary market, the benefit is limited in terms of countries actually being able to issue debt. Still rely on domestic markets and the sovereign-banking-loop in problem countries may become more entrenched. 
• Primary market purchases: if done in primary market, then this will be a direct transfer between countries and could lay the groundwork for debt pooling, something which could cause political outcries across northern Europe. 
• Risk transfer: holders of peripheral sovereign debt will likely see this as an opportunity to sell off their holdings at a higher than expected price, shifting risk to the eurozone level. 
• De facto Eurobonds: the funds will issue bonds to raise money to buy debt off struggling countries. Building on the two points above, this means that investors will sell national debt and buy European backed debt, again essentially creating a de facto European bond and debt union. 
• Conditions: must come with clear conditions otherwise could be self-defeating (removes incentive to reform). Furthermore, if, as is currently the case, countries must enter an adjustment programme to allow the EFSF/ESM to buy its bonds, there could be significant stigma attached (again reducing the benefit).  It could also mean other countries picking up the slack if a government does not properly implement its own fiscal policy (however, without a clear say on the spending programmes).

All in all then, a very mixed bag. At best this plan could provide some temporary relief to high yields but the side effects could be large and frankly these funds just aren’t big enough to fulfil this role (and their other roles) on a consistent basis. Besides, even if some time is bought they are still yet to outline to what end it would be used – better then to agree on this before starting to run down the one of the few backstops still in place to the eurozone crisis.

Should the UK contribute to the IMF?

George Osborne is in Washington DC today for an IMF meeting. In another one of those ‘domestic politics meet financial crisis’, Osborne is under pressure from his MPs not to contribute any more cash to the IMF unless there are guarantees that the money won’t be used, as the popular phrase is in Westminster goes, to “bail out a currency” (and no, we’re not talking about the Yen). There are a whole range of confusions surrounding this entire debate, so here’s an effort to clear them up:

Where are we at?

The UK can provide £10bn without a vote in Parliament, as this cash goes back to a previous commitment. For anything more, it needs approval from its MPs, which could be sticky (see below). Osborne has so far refused to contribute the £10bn, let alone even more, until certain conditions have been met.

Is contributing to the IMF the same as giving to, say, the EFSF (the euro bailout fund)?

Certainly not. The IMF is (a) a serious organisation that has saved many countries including the UK (b) its loans rank senior to other debts and so are always repaid (c) nobody has ever lost a cent on the IMF and (d) this would actually be an opportunity to modernise a 1948 organisation by giving the BRICs a more proportionate say in return for fresh capital (if you want to keep the IMF relevant, this is inevitable).

Are Tory MPs really that opposed?

There’s been a lot of shouting to the press over this issue, but the feeling is that most Tory MPs realise that contributing to the IMF could be a sensible move provided that certain conditions are fulfilled.

So what conditions need to be fulfilled for the UK to contribute?

The UK government has set out two: the top-up needs to be global (all countries contributing not only EU ones) and the money can’t be used specifically to bail out the euro.

We would add that there also needs to be a change in tact. As we told BBC five live this morning, “The main problem is that the eurozone’s approach to the crisis hasn’t changed, despite widespread criticism including from the IMF, it still fails to address the underlying problems: the lack of growth, the lack of competitiveness in the peripheral countries and the massive risks still held by the under capitalised European banking sector. Any further contributions should be conditional on a change in tack and some acceptance that this bailout and austerity policy has failed.”

What is likely to happen?

At the moment it looks as if the IMF will reach its target of $400bn, possibly even without funds from the UK, US and Canada. The two latter countries look unlikely to contribute additional funds, so the prospect for additional contributions from the full membership looks dim.

The question is, what will the IMF need to give in return? A rebalancing of power towards emerging market members is inevitable and the BRICs are pushing for it to start in exchange for funds this time around. That means there are plenty of complex negotiations still to take place. A broad political agreement may be in place by the end of the weekend, but there will be plenty of legal and technical details to be fleshed out.

Will the increase change anything?

Not really. Ultimately dispersal of IMF funds in the eurozone crisis is reliant on similar provisions from the eurozone bailout funds. So far the format has been 2/3 eurozone and 1/3 IMF. As we have previously noted, despite EU claims, the lending capacity of the eurozone bailout funds remains €500bn. This means the maximum which will likely be able to be tapped from the IMF is €250bn (although it is incredibly doubtful the IMF would ever put up that much unless the eurozone were teetering on the brink). As is often the case, the issue of IMF funds is tinkering at the edges of the crisis, eurozone leaders still fail to address the underlying problems of the crisis or even put up a sizeable bailout fund of their own.

Should the UK contribute then?

Well, first the government should wait and see if the $400bn target can be met without a UK contribution. If that is the case all the better. If not, and if all the BRICs have contributed, the UK may need to put up its £10bn (which has already been approved by Parliament). Obviously, as we have noted the usual caveats and conditions should apply and the UK along with the IMF should continue to push for a reformed approach to the crisis.

Spanish fears stoked by genuine concerns over banks and regional government spending

We've got a piece over in City AM today looking at the reasons behind the increased financial market jitters over the state of the Spanish economy. Despite the usual EU protestations that Spanish fundamentals are sound, there are definite areas of concern present in the Spanish economy - not least, as always, the banking sector. That's not to say a bailout is assured but simply that more needs to be done to ensure the stability of the Spanish economy and convince the markets that Spain is on the path to a full recovery.

See below for the full piece and see here for our full briefing on Spain:

WITH a sense of inevitability the spotlight has landed on Spain. Though the headlines proclaimed that the Eurozone crisis has returned with a vengeance, the truth is it never left. Spain is not Greece, but, many of the market fears surrounding the economy are still both well-founded and expected. There are three major causes of concern: the exposure of Spanish banks, regional governments’ fiscal profligacy and a risk that structural reforms won’t reap benefits soon enough.

The vulnerable banking sector remains the likely trigger for any future downturn in Spain. One in five of the loans by Spanish banks to the bust real estate and construction sectors is seen as “doubtful”, i.e. at serious risk of never being repaid. Against some €136bn (£112bn) in potentially toxic loans, Spanish banks hold only €50bn in loss provisions. And things are likely to get worse. House prices have declined quickly over the past six months and may fall by another 35 per cent, if there is to be the same level of adjustment as seen in Ireland.

This is troubling, firstly, because Spain cannot afford to bail out its banks. And, secondly, because Spanish banks have been the main recent buyers of Spanish sovereign debt. If these banks don’t have the cash to buy Spanish debt, then who will? This massively increases the prospect of a self-fulfilling bond run on Spain and the chances of an ill-fated Spanish bailout.

Not to be outdone, the regions look to be harbingering plenty of problems of their own. The regions have seen the amount of unpaid debt on their books rise by €10bn (38 per cent) since the start of the crisis. The total in unpaid bills now tops €36bn. Yet again, this cost is likely to be transferred to the central government, which can ill afford it, and risks the country missing its deficit target, further fuelling market jitters. The regions are also expected to contribute 44 per cent of the planned deficit reduction this year. But with the budget still hot off the press, the largest and wealthiest regions are already rejecting Madrid’s ordered spending cuts.

The good news is that the new Partido Popular government is pushing through some much needed structural reforms. Unfortunately, it will take time for the benefits to be felt, and in the short term they are likely to increase already skyhigh unemployment while doing little to boost lagging demand.

Spain remains a serious and diverse economy, with relatively good administration and infrastructure – talk of a full bailout programme is premature. The most likely outcome is some sort of aid for the banking sector – probably with the help of the European stability mechanism. As much as we hate seeing risk being transferred to taxpayers, it might be better for Spain to swallow this bitter pill now and ask for aid for its banks, than risk it dragging the whole economy – and the euro – over the edge.

Not so bullish now? The short term prospects for Spain inside the eurozone

In a new briefing, Open Europe assesses the state of the Spanish economy in light of recent budget proposals, announced by the Spanish government in full today. Spain is not the “next Greece” - it remains a serious and diverse economy, with relatively good administration and infrastructure. However, the increasing exposure of its banks to potentially toxic loans, the difficulty in curbing Spanish regions' spending and the risk of reforms not taking effect quickly enough, all raise serious questions as to whether the Spanish economy will make it through without some sort of external help.

Key Points

• Given its size, the fate of the Spanish economy will also largely decide the fate of the euro. €80bn of €396bn (1/5) in loans that Spanish banks have made to the bust construction and real estate sectors are considered ‘doubtful’ and potentially toxic, meaning at serious risk of default, with the banks only holding €50bn in reserves to cover potential losses. Already dropping, house prices could potentially fall another 35%, meaning that Spanish banks will almost certainly face hefty losses as more households default on their mortgages.
• In such a scenario, the Spanish state is unlikely to be able to afford to recapitalise its banks, meaning that the eurozone’s permanent bailout fund (the ESM) would have to step in, shifting the cost to eurozone taxpayers.
• As domestic banks are currently the main buyers of Spanish government debt, this could also lead to major funding problems for Spain. The chances of a self-fulfilling bond run on Spanish debt would increase massively in this scenario, threatening to push the whole country into a full bailout.
• Containing spending in the Spanish regions is also key to Spain rebalancing its books. The level of unpaid debt on the balance sheets of local and regional governments has risen by €10bn (38%) since the start of the crisis (now topping €36bn). This will likely be paid off by the central government, increasing the country’s debt and deficit.
• Spain’s various reforms, particularly to the labour market, are welcome, but are themselves not enough to stop a bond run, as it will take time before they bite. The country’s long- term unemployment has now reached 9% of the economically active population, and youth unemployment reached 50.5% last month. This is threatening the long term productivity of the economy and whether Spanish society can sustain this level is unknown.

A Spanish bailout is far from a forgone conclusion, but more work needs to be done to avoid one. Open Europe recommends:

• Spanish banks double their provisions against souring loans and commit to thorough stress tests.
• Strengthen labour market reforms, particularly to relieve the welfare burden on state finances, including: end wage and pension indexation to inflation, reduce size and duration of benefits, limit collective bargaining, reduce redundancy costs and improve the business climate.

However, these reforms will only stand the test of time if they enjoy political buy-in across Spanish society and are seen as democratically legitimate, rather than being imposed from outside.

To read the report in full, please click here,
http://www.openeurope.org.uk/Content/Documents/Pdfs/Spain2012.pdf

A credible Greek threat?

The Greek Public Debt Management Agency put out an interesting press release (PR) yesterday. We won’t go over all of it, since it’s been heavily covered in the press, but it did raise one interesting point:

“The Republic’s representative noted that Greece’s economic programme does not contemplate the availability of funds to make payments to private sector creditors that decline to participate in PSI.”

This is widely being seen as a warning to those who hold Greek bonds governed by foreign law and who therefore may be more inclined to hold out due to the extra protection offered under foreign law (they are also subject to higher CAC threshold, meaning CACs are harder to use). Greece essentially says that any bondholder who doesn’t take write downs will be defaulted on (except the ECB).

So, is this a credible threat?

Well, firstly we won’t find out until 11 April since that is the settlement date for foreign law bonds under the restructuring plan.

But more importantly it raises the question of whether Greece could be setting itself up for a second default, at least in technical terms. Let us explain:

Greece will certainly be judged to be in default by the rating agencies after CACs are triggered, but once the bond swap is completed and new bonds are issued it should come out of this rating fairly quickly. Yet, a month later it could again trigger CACs on foreign law bonds. Even worse, it could just leave these bonds and default on them through non-payment as and when payments are due (this could run long into the future). If this constituted another default it would have a negative impact on funding for Greek banks and the stability of the economy - so would be something to avoid.

Ultimately, it comes down to whether the new Greek bonds have ‘cross-default clauses’ in them – which means if Greece defaults on other bonds it will default on these too. From what we can see, the new bonds do not have general cross-default clauses (despite earlier versions of the plan including them), only ones which apply to the new group of bonds which exist after the restructuring.

This makes the threat to default on the remaining foreign law bonds much more credible. It would still be an extreme course of action, but one which looks increasingly attractive given the extra debt relief it could deliver (which Greece will need).

This is something which bondholders would do well to keep in mind if they are planning to try and get paid out in full.

IIF on a disorderly Greek default

A leaked document from the Institute of International Finance (IIF) has been doing the rounds recently and has some rather alarming statistics regarding the cost of a disorderly Greek default in it (see here for full doc). The document is well worth a read if not just because it sheds some valuable light on the thinking inside an institution which, up until the few months ago, very few people had any knowledge of.

As far as we’re aware the doc was first released by Athens News (we’ve done an interview with them presenting our thoughts which we will post in due course), but for now see our initial thoughts on the claims that a disorderly Greek default could cost as much as €1 trillion:

- The IIF does have a vested interest in seeing the current plan succeed and has played a substantial role in negotiating it, which should be kept in mind when reading their analysis of the ‘alternative’ of a disorderly default.

- As our latest report on Greece highlights, the current plan for Greece does not actually decrease the prospect of a disorderly default. It offers little real debt reduction and simply transfers the debt from private to public sector (making any future default more costly for taxpayers). If anything then, the warnings in the IIF report could also be a read as the potential consequences of the current path of action which risks shifting the cost of a disorderly default further onto taxpayers – the consequences of which could be hugely problematic for Europe and the global economy.

- A disorderly default is the worst case and would be incredibly painful for Greece and the eurozone, however, to present it as the only alternative to the current plan is misleading. This is a diametric choice engineered by the EU/IMF/ECB and even the IIF. There is still the option of a managed restructuring offering a greater write down with a simpler process and therefore better value for money than the current plan.

- The document mentions the social cost of a disorderly default, which would be very high, but the IIF and the troika continue to ignore or just accept the social costs of the current plan. The massive austerity threatens to create a downward spiral in the economy, while the riots show a glimpse of the tensions simmering underneath the surface in Greek society.

- There is much discussion of contagion but there has been little thought given to the potential knock on effects of the current plan, from aspects such as the legal gymnastics to protect the ECB to the lack of a comprehensive solution.

Does this document, then, simply constitute scaremongering on the part of the IIF?

That may be going a bit far, but as we point out above there are certainly caveats to consider when examining their estimates. The key point is that the current plan simply kicks the chances of disorderly default further down the road, beyond the end of this year at best. However, at that point, the potential for dire consequences of a disorderly default set out in the IIF report, will not have gone away.

The second Greek bailout: bad for Greece, bad for eurozone taxpayers

Ahead of today’s EU summit, Open Europe has published a new briefing arguing that the second Greek bailout is bad for Greece and bad for eurozone taxpayers. The briefing notes that of the total amount (€282.2bn) that is entailed in the various measures now on the table to save Greece – through the bailouts and the ECB – only €159.5bn, or 57% will actually go to Greece itself. The rest will go to banks and other bondholders. Furthermore, immediately following the restructuring, Greece’s debt to GDP will still be 161%, a reduction of only 2% compared to where it is now. On top of this Greece has to undertake extensive budget cuts amounting to 20% of GDP in total – a level which no other country has even attempted in recent history.

By 2015, once the first and second Greek bailouts have been completed, as much as 85% will be owned by taxpayer-backed institutions (EU/IMF/ECB).This means that in the event of a likely default, a huge chunk of the losses will fall on European taxpayers, potentially leading to significant political fallout in countries such as Finland, the Netherlands and Germany. The briefing concludes that, given the sizeable debt relief needed in Greece, a fuller coercive restructuring would have been a simpler and more effective option from the start and should still be pursued.

To read the full briefing click here.

Markets vs. Democracy - Round 278

The Irish government has just announced that it will hold a referendum on the euro fiscal compact. The Irish Taoiseach Enda Kenny said he had taken advice from the country’s Attorney General, and made the decision to call a public vote. He also said he would sign the fiscal compact treaty at the meeting of EU leaders on Friday, and the details and arrangements for the referendum will be sorted and announced in the coming weeks, with a vote to be held before the summer.

The Irish government had previously said that the chances (or risks if you ask the markets and EU elite) of a referendum were always 50-50, so this was far from a foregone conclusion. And, as Zerohedge put it, markets have reacted badly to the news of democracy, with the euro weakening significantly. But what is the precise significance of this announcement?

• The vote will essentially determine whether Ireland has access to future bailout funds or not. For a country to access the ESM, the eurozone's permanent bailout fund, it must have ratified and fully adhered to the treaty, according to the terms attached to the deal. The Irish government has already given indications that it will tie its approach closely in with the prospect of further bailout funding, with Deputy PM Eamon Gilmore pointing out the link between emergency funds and the fiscal pact approval. These scare tactics are likely to grow throughout the referendum campaign, with the flip-side of rejecting the treaty being seen as tantamount to a vote for eurozone exit. In other words, the Irish will vote with a gun to their head.

• It provides yet another illustration of the clash between different parliamentary/constitutional democracies (in this case the German vs the Irish constitutions) that time and again have served as an ‘obstacle’ to perceived crisis solutions.

• Irrespective of the outcome, the vote will not derail the euro fiscal compact as it only requires 12 member state ratifications before entering into force, though it could well limit the impact of the pact.

• Those that thought that the complicated political situation in Europe could be reduced to a simple 26 vs 1 narrative, following Cameron’s ‘veto’ to an EU27 Treaty back in December, have received another reminder as to why that isn't the case.

In sum, it would have been difficult to avoid this referendum and we're glad the Irish government did not engage in the legal gymnastics that have been going on elsewhere in the eurozone (*cough* Frankfurt). If further fiscal integration is ever going to succeed (leaving aside whether it's desirable), it will have to happen with a clear and strong mandate from the people. This is also a practical point which market players should ponder. Changes built on a clear mandate from the people (particularly when wrapped in pretty heavy austerity) have a far greater chance of standing the test of time.

But the likely approach of tying a Yes vote to access to more bailout funds and greater security and a No vote to a eurozone exit is already worryingly over-simplistic. Finally injecting some democracy into the eurozone crisis should not be watered down by pigeonholing it into tightly defined categories.

That said, as we've noted, the fiscal pact has already been watered down itself and signing up to it would not be the end of the world for Ireland - but only if that's what the people decide after a full discussion of the issue.

Many questions around the second Greek bailout remain unanswered

We finally have an agreement on the second Greek bailout…in principle. It only took eight months. If you’re of the belief that a disorderly Greek default would have triggered Armageddon, the deal that was agreed (as ever ‘agreed’ is used loosely) by Euro finance ministers in the early hours of this morning is broadly good news.

Unfortunately, it is once again hopelessly optimistic and contains numerous gaps and unanswered questions which could still bring down the whole deal. This is nowhere outlined better than the damning leaked debt sustainability analysis (see here for full doc).

Below we outline a few key issues (not exhaustive by any means, there are many more) and give our take on how they could play out.

Greater losses for private sector bondholders: Reports suggest the Greek government was sent back to the negotiating table with bondholders at least four times during last night’s meeting. Nominal write downs for bond holders now top 53.5% (or around 74% net present value). The leaked Greek debt sustainability analysis (DSA) assumes a participation rate of 95%.

Open Europe take: 95%, really? We weren’t convinced the previous threshold of 90% with a lower write down would be reached and that was while potential ECB participation was still on the table. Although this target may have been agreed with the lead negotiators for the private sector, it is far from a cohesive group, diminishing the value of the agreement. It will be interesting to see how bondholders respond to the plan but we think that hold outs could well be more than 5%.

Greek ‘prior actions’: The deal includes a list of requirements which Greece must meet in the next week to get final approval for the bailout. These include: passing a supplementary budget with €3.3bn in cuts this year, cuts to minimum wage, increase labour market flexibility and reforms opening up numerous professions to greater competition.

Open Europe take: The now infamous €325m in cuts still needs to be specified. The huge adjustments to labour markets and protected professions mark a cultural shift in Greece – pushing these through will not be painless and could result in further riots.

Fundamental tensions in objectives of the programme: The DSA notes that the prospect achieving a return to competitiveness while also reducing debt is very small – the massive austerity could induce a further recession.

Open Europe take: As we have noted all along the assumption that Greece can impose massive levels of austerity and then return to growth in the next two years is a big leap and almost inherently contradictory. We’d also note that the cuts in expenditure in Greece are larger than have been attempted anywhere in recent memory (successful or failed). Likely to be substantial slippages in the austerity programme while the growth programme remains almost non-existent, essentially closing the book on Greek debt sustainability.

Further favourable treatment for the ECB: ECB and national central banks avoid taking losses on their holdings of Greek bonds but promise to redistribute ‘profits’ from these holdings so that they can be used in Greece.

Open Europe take: See our previous post for a full discussion of this issue. Markets still don’t seem too worried by suddenly being subordinated by central banks in Europe – they should be. This raises questions of the basic premise that all bonds are treated the same, based on who issued them not who holds them. As we’ve noted before, the whole concept of ‘profits’ is misleading, while any distribution would happen anyway – this is not a commitment from central banks but a further fiscal commitment by the eurozone (should really be included in total bailout funding).

Greece may not be able to return to the market even after three years: The DSA points out that any new debt issue will essentially be junior to existing debt, hampering the chances of Greece issuing new debt in 2014/2015.

Open Europe take: This point isn’t too clear but given that the eurozone, IMF and ECB will own such a larger percentage of Greek debt in 2014 any new private sector debt will be massively subordinated and at risk of taking losses if anything goes wrong with the Greek programme. Additionally after the restructuring the remaining private sector debt will be governed under English law and will have the EFSF sweetener – further subordinating any new debt issued to the market. Why would anyone want to purchase Greek debt in this situation (especially given the other concerns above)?

EFSF funding requirements: The EFSF will have to raise €70.5bn ahead of the bond swap – €30bn in sweeteners for the private sector, €5.5bn to pay off interest and €35bn to provide Greek banks with assets to use to gain liquidity from the ECB.

Open Europe take: We’ve already questioned whether raising these funds so quickly can be done and whether the approval from national parliaments will be forthcoming. Even if it is the €35bn is said to fall outside of the €130bn meaning it is expected to be returned swiftly – given the uncertainty over how long banks will need these assets (as long as Greece as declared as in selective default by the rating agencies) this may be a generous assumption.

There is also no talk of the money to recapitalise banks. This is a risky strategy given that Greek banks’ main source of capital (government bonds) will have just been wiped out significantly. The needs were previously specified at €23bn, although reports now suggest they could top €50bn. It’s not clear where this money will come from or when it will be raised. The bond restructuring will be like dancing through a minefield for Greek banks.

We’re still trawling through the responses, analysis and documents to come out of the meeting – meaning there are likely to be plenty more questions and uncertainties to come.

The one thing that is clear is that even if this bailout is ‘successful’, it will set Greece up for a decade of painful austerity and low growth leading to social unrest, while the eurozone will have to provide on-going transfers to help it keep its head above water.

Sorry to be killjoys but as Dutch Finance Minister Jan Kees de Jager put it, the deal isn’t “something to cheer about”.

More delays in Greece may not be an option...

Following another postponed meeting of eurozone finance ministers, there have been reports that the eurozone could try to delay the second Greek bailout package (possibly until after the elections in April) or just pushed ahead with part of it (the voluntary restructuring of Greek debt).

As reported by the FT and the WSJ in the past day or two, a draft of the latest bailout agreement has been circulating, however we believe that some of the issues which the drafts raises have been underplayed - particularly those that impact the chance of delaying or breaking up the bailout.

The draft lays out how some of the bailout funds will be used:

Bond sweeteners - €30bn
Funds to buy back bonds from the Eurosystem - €35bn
Funds to pay off interest - €5.7bn
Bank recapitalisation - €23bn
Total - €93.7bn (out of the €130bn bailout)

This is money needed to make the PSI successful and allow the voluntary restructuring to be completed. Firstly, this highlights that the claims by the eurozone that they could simply push ahead with the PSI without fully approving the second bailout seem to be incredibly misleading. Without this money in place there would be a huge amount of uncertainty on the part of bondholders, particularly Greek banks who would need new capital injections to survive. However, to disperse this substantial amount of money would need full approval from the eurozone and some national parliaments. Given that it is widely accepted that the PSI needs to be put into motion this week if Greece is to avoid a disorderly default on 20 March getting this money released could be a huge stumbling block.

Secondly, where would this money come from? The draft stipulates that the EFSF will issue debt to raise these funds (since it currently only has guarantees), however, it is has not pre-funded any of these commitments and suddenly flooding a subdued market with over €90bn in (possibly non-triple-A) EFSF bonds is not an effective funding strategy. There is no telling how the market will react or at what cost the EFSF will be able to borrow. The urgency of the situation feeds the uncertainty here and could be catastrophic for Greece.

Lastly, with new provisions such as €35bn for bond buy backs, will €130bn be enough to fund Greece for three years? We questioned whether this was even enough originally, now it seems even more unlikely.

The chance of getting approval for and raising this amount of funds in the time necessary (a week or two max) seems unrealistic. But it is also unlikely that eurozone finance ministers will delay the PSI further, simply because they cannot afford to. The eurozone has once again backed itself into a corner and things are likely to get worse before they get better.

Light at the end of the tunnel? Not yet...

Update 10 February, 9:45 am

Greece's letter of intent (29 pages including the annexes) with all the envisaged austerity measures is available here



After countless missed deadlines, numerous strikes and some very exasperated European officials it seems there is an agreement in Greece. Finally.

Despite the failure to achieve one overnight, an agreement had been coming given that only one point of disagreement remained – on pension reform. The Greek political parties refused to cut primary or supplementary pensions further, leaving a €300m gap in the Greek budget – pretty small given the huge sums at play in the Greek deal.

The statement just released by the Greek PM is minimalist to say the least - only two sentences. It confirms that a deal has been reached and suggests the total bailout size will be €130bn.

So what does this deal mean?

Well, it is positive in that it moves the whole Greek discussed forward one large step, but it isn’t the end of it – not by a long way. Essentially, the Greek unity government has now agreed and committed to a new programme of austerity, just one part of the wider Greek package and in itself not necessarily productive. As we have flagged up elsewhere austerity alone cannot and will not solve the Greek problem and could be on the verge of becoming counterproductive given the economic (low growth) and political (civil unrest) implications.

It also allows a deal to be presented at this afternoon’s meeting of eurozone finance ministers, allowing progress on some of the other remaining questions, which include:

- What structure will the bailout take (in terms of allocation of funds and distribution of payments)?
- What will the total level of debt reduction from the restructuring be?
- When will the restructuring begin and will it be in time to pay off the €14.4bn in debt maturing on 20 March?
- Will the European and Greek parliaments approve all aspects of the deal?
- What role is the ECB playing? Will it submit its holdings of Greek debt for restructuring?

This afternoon’s press conference with ECB President Mario Draghi was fairly cryptic on this last point, with Draghi trying to dodge questions about the ECB and Greece for the most part – although he did drop a couple of hints.

Our take is that the ECB may, very reluctantly, take some part in the Greek restructuring. It will not take any losses and is hesitant to transfer its bonds to the EFSF, the eurozone bailout fund, even at cost price. One possible outcome could be that the ECB will distribute the potential €15bn in profits from its holdings of Greek debt to the eurozone countries (since they are the ECB’s backers and already share in its profits) to be put to use in funding Greece. How this can be done upfront, especially without using the EFSF, remains to be seen.

Additionally, the fact that the Greek PM’s statement specified the bailout amount as €130bn suggests that there will still be a budget gap in Greece which needs to be filled, even with the agreement on the additional austerity. An ECB contribution seems to be the only remaining viable way to close this gap then.

So, we are eventually one step closer to another bailout of Greece. The end to the uncertainty is positive, but in the long term it seems to be just another step along the wrong path.

Greek end-game: Day 2 (or rather 700)

The end-game in Greece continues to rumble on into another day of negotiations. On the rhetoric front, matters have heated up as well. Neelie Kroes, the Dutch EU commissioner told De Volkskrant, "It's always said, if you let one nation go, or ask one to leave, the entire structure will collapse. But that is just not true."

Talks between the leaders of the Greek political parties will continue at 2pm GMT today, after Greek Prime Minister Lucas Papademos held talks with the EU/IMF/ECB troika late into the night yesterday. Unfortunately, it doesn’t seem as if much was achieved. We expect that the issue of this new debt repayment account for eurozone bailout funds was broached and developed with the (likely reluctant) Greek authorities. Essentially, this funnels more funds into paying off Greek debt rather than using it to boost competitiveness or improve governance in anyway.

Following the talks Greek Finance Minister Evanagelos Venizelos was surprisingly blunt, saying, "Unfortunately the negotiations are so tough that as soon as one chapter closes, another opens."

As we noted yesterday, some progress was made towards deal between the Greek political parties, as they agreed in principle to 15,000 additional public sector job cuts, a reduction in the minimum wage and supplementary pensions. However, these cuts still do not meet the demands made by the troika, while the details of how they will be implemented are still to be ironed out.

We will continue to update this blog with developments in Greece throughout the day.

The Greek end-game?

Greece is on a "knife edge". That was how Greek Finance Minister Evangelos Venizelos put it on Saturday ahead of emergency talks between Greek political parties and the EU/IMF/ECB troika (with eurozone countries and private sector bondholders thrown in there somewhere as well).

We're sure you're thinking - surely, we've heard this all before? That may be the case, but unfortunately this time may be different. For once, Greece has a hard and fast deadline to meet to avoid a disorderly default.

But lets back up a second, whats the current disagreement between the Greek government and its creditors all about? Well, despite seemingly getting talks with the private sector bondholders pretty much finalised, new gaps between the Commission/ECB/IMF troika and Greece have opened up over the second bailout (as we predicted in our previous posts). The main areas of contention (as expected) seem to be the desire for eurozone countries to see greater wage and spending cuts. However, the three party coalition which underpins the 'technocratic' government of Lucas Papademos is refusing to back greater austerity - they simply believe their parties and the public won't support it. They may well be right but they may also have one eye on upcoming elections (as has been suggested). All of this puts the eurozone at yet another impasse. There is no way eurozone states will agree to disburse another €130bn - €145bn without a greater commitment to austerity in both the Greek public and private sectors. But without support from all three parties any commitment would be an empty one.

Usually, this would spell another round of talks, negotiations and some form of muddling through. However, this time they have essentially set a deadline of the start of this week to finalise the entire Greek package. The reason for this is the €14.4bn in Greek debt which needs to be paid off on 20 March. For the next bailout to be released, the 'voluntary' restructuring needs to have taken place and the new austerity measures need to be making their way through parliament. Without the money from the second bailout Greece will not be able to pay off this maturing debt. Most experts and those involved expect that six weeks is the minimum amount of time it will take to put the restructuring in place - meaning that it needs to get underway this week, hence the deadline.

There is also the 'side' issue of how much money will actually be paid out in the second bailout and whether the official sector (eurozone loans/ECB) will take losses in the restructuring. These are in themselves massive issues which will affect the future of the eurozone - particularly the role of the ECB (as we have previously discussed here). But in the eyes of the eurozone these discussions cannot even take place until there is a consensus from the Greek political elite to commit to greater austerity. Unfortunately, then, there are still some very big issues to be ironed out, even after the current disagreement is settled.

The term "knife edge" does seem fitting here...

Updates 06/02/2012: We will continue to update this blog with developments from Greece throughout the day.

09.30am - Reports this morning suggest Greece has been set a deadline of noon to find an agreement amongst the political parties in favour of the necessary austerity. However, this has been denied by Greek officials, who suggest the deadline is simply for an agreement to be struck ahead of the next eurogroup meeting (which was due to take place this afternoon but has now been moved to an undefined date).

12.20pm - RANsquawk is reporting that the Greek political parties have reached an agreement on a 20% wage cut and a reduction in supplementary pension, pushing them closer to a deal with the troika. No formal announcement yet but one is expected later today. Meanwhile, Merkel and Sarkozy have been holding a joint press conference in which (other than praising each other) they continued to reiterate their firm stance on Greece, although also stating that they expect an agreement very soon. If there is a consensus found in Greece today we can expect an emergency Euro-group meeting tomorrow or Wednesday.

2.00pm - Despite rumours of an agreement being reached, it looks as if the negotiations are far from over. Greek Prime Minister Lucas Papademos is set to hold talks with the troika later this evening to update them on his progress. Papademos will then hold another meeting with Greek political leaders tomorrow, presumably to communicate any messages which the troika wish to send. We assume the message will be for greater austerity. So don't expect a Euro-group meeting until at least Wednesday.

2.20pm - France and Germany earlier requested that Greece create a special account targeted at financing Greek debt, although specifically paying off interest rather than the total amount for now. The plan remains unclear and undeveloped but seems very similar to the recent German demands that Greek bailout funds go towards paying off debt first and foremost. Could the issue of an EU budget commissioner be revived during these negotiations then? Unlikely, but still risky ground for the French and Germans to tread given the heightened tensions since that leaked document.

5.20pm - After a slightly quieter afternoon than anticipated, AP has announced that there is a consensus between the Greek parties to accept the demand to cut 15,000 public sector jobs. A deal looks to be edging closer but is far from sealed yet. There is also set to be a general strike for the whole day tomorrow, meaning there is a good chance of massive protests and possibly even large riots in Athens.

6.15pm - Things have picked up again in the last hour, particularly with Greek PM Lucas Papademos reportedly asking the Greek Finance Ministry to do a thorough assessment of what a Greek exit from the eurozone would mean. Papademos is currently in a meeting with the troika (which began at 6pm), during which we're sure these reports will be broached, mostly likely with some disdain on the part of the troika. In the meantime, Merkel and Van Rompuy have been reiterating their positions by continuing to insist that the situation is not as bad as it seems and that Greece can avoid a default.

Germany still doesn’t understand Greece

Despite being locked together in economic turmoil for almost two years, the reports which emerged over this weekend further suggest that Germany still does not understand the depth of some of the problems facing Greece (and that they cannot be tackled by a one dimensional policy).

We are of course referring to the leaked German proposal calling for Greece to cede budget sovereignty to the EU. Naturally, this is an impossible claim and was roundly rejected by Greece and the Commission, while German officials have spent the weekend trying to douse the flames behind the scenes.

It is not clear whether or not this was ever a serious proposal on the part of the German government, although stern talk from the German Finance Minister Wolfgang Schaeuble and the Economy Minister Philipp Roesler suggested that the sentiment behind the proposal was real enough. We will not dwell on the obvious and well documented political and democratic questions which this raises – it is clearly a step too far which could and would not ever be accepted by the EU in the current framework. There has been talk of a Eurozone finance ministry at some point in the future, but this stands apart from asking a single country to undemocratically cede control of taxation and spending to the EU- meaning the proposal was destined to sink as soon as it hit the water.

This substantial issue aside, the sentiment behind the proposal reveals a continuing misunderstanding of the Greek problem from the German government. Despite all the talk of “growth and jobs” in recent days, it is clear the emphasis is on austerity above all else. It also raises serious questions about Germany’s belief that Greek debt could ever be sustainable under Greek control – which should be a concern for German citizens since they are about to finance the largest share of another €130bn bailout.

Fundamentally though, as a recent OECD report noted, the problems within Greece run a lot deeper than just the ability to agree on the ‘right’ policies. For all its shortcomings, the Greece has instituted a multitude of deficit and debt reduction plans over the past year. However, the real issue comes with the implementation of these reforms, as the OECD comments:

“Ministries take decisions but these are often not reflected in concrete results. A succession of reforms launched in recent years (including reforms of the administration) did not bring the expected results, due to poor implementation.”

So, the problems do not necessarily lie with the politicians or the top level civil servants (or at least they do not stop there) meaning that shifting top level control to the EU would make very little practical difference.

These problems cannot be tackled overnight or by simply imposing more austerity. Germany has continually refused or failed to understand the nature of the problems facing Greece despite much of the public posturing. With the outcome of the Greek restructuring negotiations still far from clear, a change in tact is needed - although it could well already be too late.

More IMF contributions? conditionality is king

The rumours were finally confirmed today as the IMF released a statement announcing its plans to increase its funding base by up to $500bn. There’s been a lot of talk in the British media in recent weeks about the potential increased UK contributions to the IMF, and not much of it positive. The coverage has painted any additional UK contributions as tantamount to a eurozone bailout – this is a tempting narrative but ultimately it may be too simplistic. When it comes to the IMF there are a few subtleties which need to be considered, as we outline below.

Firstly, no-one has lost money lending to the IMF…ever. It is always the most senior creditor, meaning it will be the first to be paid back. Therefore the potential risk of this lending is minimal, no matter where it goes. Moreover, as Cameron has pointed out, the contributions do not impact the UK’s debt or deficit, so it is not really a question of giving up other priorities to fund the IMF.

Additionally it seems as if the money will be paid into the IMF general reserve fund and not a specific eurozone fund. It is also likely that other members will contribute, so this moves the point away from being simply about the UK and the eurozone and becomes more about the UK's participation in the global economy. Being a member of the IMF is an important part of the UK’s global role and its foreign policy approach. Unilaterally declining to contribute funds and possibly removing the UK from the IMF would have an impact far beyond the UK’s role in the eurozone crisis.

Furthermore, given the failures of the EU in the eurozone crisis, shifting the balance of power towards the IMF would be no bad thing (in the right circumstances, of course). The IMF has conclusively argued for a large write down of debt in Greece (as we also have) and has the expertise and experience to deal with the challenges of restructuring struggling economies.

That said there are a few conditions which the Government should consider:

- The funds must go into a general fund not a eurozone specific one and must be matched proportionately by all other members of the IMF.
- Larger IMF contributions to the eurozone must be matched by a greater say in the crisis resolution. Generally, it should be made clear by the IMF and its members that the current approach is not working – the focus needs to switch to debt restructuring combined with increased competitiveness and growth.
- The funds must not be seen to impact on Cameron’s decision to veto the recent European treaty. Although IMF funding was mentioned, this is a separate issue since it is coming from a direct IMF request not the EU.

So, it comes down to this: The UK should not hand out further contributions to the IMF without conditions. With these conditions met, the result would not be the same as simply handing more money directly to the eurozone. Alas, in the end, even an extra $500bn at the IMF’s disposal may not make a huge difference the outcome of the crisis.

The draft euro fiscal pact: not great news for the eurozone either...

We’ve already reviewed what the latest draft version of the fiscal compact means for the UK (not much good) being the first in the UK to publish the draft of the compact (beating the Telegraph by a hair). But let’s not forget what the treaty is supposed to be about – saving the eurozone. There are still those out there, not least the ECB and the IMF, who believe that this treaty can form an integral part of the solution to the eurozone crisis (along with an increased firewall and structural reforms).

Looking at the latest version of the treaty it seems that not much has changed in the fiscal rules department. As always the 60% debt limit and 3% deficit limit provide the framework, while the 0.5% limit on ‘structural deficit’ is included as with the previous draft. There is no further detail provided on what exactly the ‘structural deficit’ is envisaged to be, although there are some qualifying statements which suggest such stringent rules could be waived in the case of “exceptional economic circumstances”. Still very vague with some key ideas not clearly defined. This doesn’t fill us with confidence. Remember this compact is meant to provide the original stability & growth pact with some teeth, by actually establishing some tools to enforce the fiscal rules.

Article 5 of the new draft suggests that the budgets of countries under excessive deficit procedure will be submitted to the European Commission and Council for “endorsement”. This isn’t much, if at all, different to the new six pack rules, while it again remains unclear what they mean by “endorsement” – will the Commission and/or Council retain a binding vote on national budget plans?

In terms of the overall debt level, the commitment for countries which exceed the 60% debt to GDP ratio to reduce their debt by one twentieth every year remains. However, this still raises lots of questions over implementation. Will this rule apply as soon as the treaty comes into force? Take Italy for example: if it was applied from this year, the government would have to potentially find a €108bn in savings or a 7% of GDP swing in the budget, in order to cut the debt by the required amount. This is more illustrative than anything, but the key point is the tension it represents. Realistically the rules cannot be enforced next year or possibly even the year after, otherwise too many countries would be sanctioned and be forced into ever greater austerity. However, to convince markets, there needs to be a clear plan for implementation and some signs that the immediate problems will be tackled. This latest version of the draft simply does not tackle these issues, nor do any of the wider discussions relating to the fiscal compact.

As we pointed out with our post on the draft’s impact on the UK, there is a widely increased role for the EU institutions. In particular, countries which are seen to have broken the fiscal rules can be taken to the ECJ by other members or the Commission. This gives the proposals significantly more teeth, but given the UK’s position it is far from a foregone conclusion that EU institutions will be able to play this role under the finalised new treaty. It also seems that much of the stuff in the compact can be done within the existing treaties anyway, begging the question why this, new over-lapping deal is necessary in the first place (and yes, we do appreciate German domestic concern).

Until the significant amount of uncertainty is removed from the fiscal compact – in terms of implementation, use of institutions, timeline, severity of sanctions and exceptions it is likely that markets will continue to be underwhelmed by it. Unfortunately, while these short comings persist eurozone leaders continue to meet and talk up their negotiations, which only seems to add to the eventual let-down.

Get ready for another rollercoaster ride

As we noted last week, 2012 is going to be another incredibly messy year for the euro (hardly an earth-shattering prediction).

Everyone agrees that the next few months are going to be a crucial phase in the eurozone crisis. If a long term solution isn't found it is likely that one never will be and the window of opportunity for saving the eurozone in its current form may close for good (if it hasn't already). We've been here before of course (remember 'six weeks to save the euro'), but there needs to be, at least, some sort of settlement over Greece, to avoid a hard, uncontrolled default in the first half of 2012. Below are the key dates to watch, focusing on meetings and bond auctions - expect this list to increase substantially given the almost weekly meetings between eurozone leaders these days. It's going to be a busy first quarter for euro leaders - summits of various kinds are in bold:

--Monday, Jan. 9: Meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy in Berlin
--Tuesday, Jan. 10: Ireland's troika of lenders expected to start latest review of country's bailout program.
--Thursday, Jan. 12: ECB interest rate statement and press conference. Spanish (€3.5bn) bond auction.
--Friday, Jan. 13: Italian bond auction (€6bn).
--Monday, Jan. 16: Troika of international inspectors expected to return to Greece to resume talks on new bailout deal.
--Thursday, Jan. 19: Spanish (€3.5bn) and French (€8bn) bond auction.
--Friday, Jan. 20: Troika talks in Greece expected to end. Ireland's troika of lenders releases its latest quarterly review of the country's bailout.
--Sunday, Jan. 22: Finnish Presidential elections
--Monday, Jan. 23: Euro-zone finance ministers meeting. --Tuesday, Jan. 24: European Union finance ministers meeting.
--Thursday, Jan. 26: Italian bond auction (€4.5bn).
--Monday, Jan. 30: EU leaders summit. Italian (€7bn) and Belgian bond auctions (€4bn).
--Tuesday, Jan. 31: Greece aims to conclude talks detailing new EUR130 billion loan deal, debt-exchange program with private-sector creditors by this date.

--Thursday, Feb. 9: ECB interest rate statement and press conference.
--Wednesday, Feb. 15: eurozone Q4 2011 GDP estimate released.
--Friday, Feb. 17: EUR1.6 billion Greek T-bills maturing.
--Tuesday, Feb. 28: ECB three-month and three-year long-term refinancing operation. Italian bond auction.
--Wednesday, Feb. 29 to Thursday Mar. 1: Italy sees €46.5bn in debt maturing.

--Thursday, Mar. 1: EU leaders meet in Brussels for a two day summit.
--Thursday, Mar. 8: ECB holds monthly meeting
--Saturday, Mar. 10: Slovakia holds parliamentary election
--Monday, Mar. 12: eurozone finance ministers meet in Brussels --Tuesday, Mar. 13: EU finance ministers meet in Brussels
--Tuesday, Mar. 20: Potential Greek default? Greece sees €14.4bn in government debt mature, needs to have next tranche of bailout funds and second bailout in place to be able to cover this cost.
--Friday, Mar. 30: eurozone finance ministers meet in Copenhagen --Saturday, Mar. 31: EU finance ministers meet in Copenhagen; Deadline for new Spanish government to present 2012 budget to Spanish parliament

--Sunday, Apr. 22: French Presidential election

Business support for Cameron's EU veto loud and clear

Much was said about business' opinion of Cameron's EU veto in the immediate aftermath of this month's summit but, now that the dust has settled, the picture is starting to become much clearer.

Today, in a letter to the FT, orchestrated by Open Europe, 20 leading business figures express their support for Cameron's veto and his willingness to "stand up for an outward-looking and competitive Britain."

Here it is in full:

Sir, It is impossible to know just how European politics or economics will develop at this juncture. However, since the UK prime minister’s recent veto of a new European Union treaty, one major point of principle is clear: Britain does not want, or intend, to be dragged deeper into a more centralised and over-regulated EU with ambitions to become a political union.We therefore believe that David Cameron deserves the full support of the business community. On this occasion, he was seeking safeguards for the financial sector, still one of Britain’s biggest industries, employing more than 1m people and contributing more than £50bn in tax revenues, but the principle is applicable to many other sectors of our economy, including manufacturing, which employs more than 2.5m people.

Those who would portray Mr Cameron’s use of the veto as bad for jobs and growth or as leaving the UK “isolated” are mistaken. The real threat to employment is the euro crisis, which was unaffected by his veto and which the recent summit did little to address. Britain has great potential to compete across the globe, if freed from badly targeted and trade-hampering government intrusions, whether from London or Brussels. Irrespective of the fate of the euro or the ability of weakened southern European economies to prosper under severe austerity programmes, it is most welcome that the prime minister has shown himself willing to stand up for an outward-looking and competitive Britain.

Rodney Leach,

Chairman, Open Europe

Anthony Bamford,

Chairman, JCB

John Barton,

Chairman, Brit Insurance Holdings

Roger Bootle,

Economist, Capital Economics

Mark Darell-Brown,

Managing Partner, Brown Vanneck

Douglas Graham,

Chairman, Express & Star Midland News

Gerard Griffin,

Portfolio Manager, GLG Partners

Robert Hiscox,

Chairman, Hiscox Underwriting

John Hoerner,

Former Chief Executive, Tesco Clothing

Geoffrey Howe,

Chairman, Jardine Lloyd Thompson

Luke Johnson,

Chairman, Risk Capital Partners

Tim Martin,

Chairman, JD Wetherspoon

Nigel McNair Scott,

Finance Director, Helical Bar

David Ord,

Managing Director, Bristol Port Company

Neil Record,

Executive Chairman, Record Currency Management

Nigel Rich,

Chairman, Segro

Hugh Sloane,

Co-founder, Sloane Robinson

Brian Williamson,

Simon Wolfson,

Chief Executive, Next

Signed in a personal capacity

Meanwhile, an IoD poll has revealed that 77% of its members agree with the PM’s use of the veto, with only 19% disagreeing. The survey found that 63% of IoD members would like to see the UK in a looser relationship with the EU, including 42% who would like to see a repatriation of some powers.

Add to this our recent poll of financial services managers, before the summit, which showed that 69% supported the introduction of a British veto on EU financial rules even if it reduced access to the Single Market, and the picture is one of widespread business support not only for Cameron's veto but for a more liberal and competitive Europe.

How will the UK judge the role of the ECJ?

A draft of the new European treaty proposed by France and Germany has been leaked and attention has immediately turned to the thorny issue of the role of the EU institutions in enforcing or policing the new deal – remember the UK's line is broadly that they can't, a key source of potential leverage in future talks.

The proposed document would see a role for the European Court of Justice in judging whether national governments have transposed a new “balanced budget” obligation and, if this is breached, an automatic “correction mechanism” into national law. The new treaty states:

NOTING that compliance with the obligation to transpose the "Balanced Budget Rule" into national legal systems at constitutional or equivalent level should be subject to the jurisdiction of the Court of Justice of the European Union, in accordance with Article 273 of the Treaty on the Functioning of the European Union.

The question is whether this is allowed under EU law, can the ECJ be used for this? (NB, the draft foresees no role for the ECJ in enforcing any sanctions but simply judging whether the new rules have been adequately transposed into national law.)

Article 273 of the EU Treaties, cited by the new treaty, states that:

The Court of Justice shall have jurisdiction in any dispute between Member States which relates to the subject matter of the Treaties if the dispute is submitted to it under a special agreement between the parties.

So this EU Treaty article clearly provides the new group with a hook on which to try and hang the new arrangement and get the ECJ involved. Article 273 would allow the ECJ to be used to judge a dispute (in this case whether the “balanced budget” rule has been adequately transposed), as long as the subject of the dispute is “related” to the EU Treaties. The question is whether this 0.5% rule can reasonably be seen as “related” to the Treaties. This is where the legal grey area begins and where it seems that the justification for ECJ involvement is iffy to say the least.

The existing EU Treaties contain obligations for governments to remain within a 3% deficit limit and a 60% debt to GDP limit. But there is no mention of the new 0.5% “structural deficit” limit proposed by the new treaty.

The 0.5% limit is a new obligation. It is therefore a legal stretch to say that this falls under the category of things to which the EU Treaty “relates”. Using the ECJ to judge whether this new obligation has been transposed properly is therefore also a huge legal stretch and one that the UK would be well advised to investigate and possibly challenge. If Cameron does wave the proposal through it will certainly raise political questions about what his veto actually achieved.