The lessons/ policy responses and the future of the euro

The lessons/ policy responses and the future of the euro Maja Kadievska Vojnovik Vice-governor National Bank of the Republic of Macedonia

Outline: • The lessons from the Eurozone (EZ) crisis /policy responses 1.Growth model of GIIPS 2. Problems in the structure of the EZ 3. Mispricing of risk by capital markets 4. Crisis prevention and resolution mechanism needs to be in place before the next crisis 5. Surveillance and monitoring of regional financial markets should be strengthened 6. Banks need to be recapitalized quickly after crisis • The future of the Euro

1. Growth model of GIIPS The growth modelof GIIPS (Greece, Ireland, Italy, Portugal and Spain) based on: • Large external imbalances -large CAD financed by debt-creating flows; • The falling labor productivity and rising labor costs; • Lavish social security systems with inefficient governments - high and permanent deficits is NOT SUSTAINABLE. Solution: Austerity Programs and Structural Reforms!!!

1. Growth Model -Large wage increases in excess of productivity growth/rising ULC Source: OECD

1. Growth Model - The appreciation of REER impaired export performance Source: IMF

1. Growth Model- Worsen competitiveness vis-à-vis the core countries, in particular Germany, caused large CAD Source: IMF

1. Growth Model -Global financial crisis of 2008–2009, spilled over into a sovereign debt in early 2010 Source: Eurostat

1. Growth Model -Government bailouts of banking systems contributed to an increase in already high public debt levels Source: Eurostat

2. Problems in the structure of the Eurozone A common monetary policy and currency without fiscal union, centralized budget authority or system of fiscal transfers across members to smooth out asymmetric shocks; Solution: European Governance Reforms In December 2011, announced a new "Fiscal compact“: • Introduction of fiscal rules in national constitutions -the structural deficit not exceed 0.5% of GDP; • European Court of Justice (Luxembourg) will be responsible for the proper transposition of this rule; • Introduction of automatic sanctions for countries that violate the rules of the Stability and Growth Pact (deficit ceiling of 3% and the debt ceiling of 60%)automatic sanctions (0.2% of GDP, blocking money from the Structural Funds);numerical benchmark for the debt (1/20 to reduce annual average calculated for three years);

3. Mispricing of risk by capital markets • European monetary unification brought convergence of interest rates among EZ members, but the financial integration did not automatically lead to the efficient allocation of capital. Solution: the risk assessment on country level

3. Mispricing of risk by capital markets -Since March 2010, the borrowing costs for the GIIPS increased significantly Source: Bloomberg

3. Mispricing of risk by capital markets The cost of insuring sovereign debt against default soared

Credit Rating by Countries 2007/2012 Source: Bloomberg

4. Crisis prevention and resolution mechanism needs to be in place before the next crisis Solution: Temporary, three-year lending facility- European Financial Stability Facility (EFSF), but more importantly - Permanent rescue fund, the European Stabilization Mechanism (ESM) in 2013. In 2012, EFSF and ESM will overlap with total ceiling of 940 billions euro

Financial Assistance from other EZ governments and IMF Source: IMF

5. Surveillance and monitoring of regional financial markets should be strengthened Solution: New supervisory framework: • As from January 2011, the three European supervisory authorities (ESAs) and a European Systemic Risk Board (ESRB) were established to replace the former supervisory committees: • European Banking Authority; • European Securities and Markets Authority, • European Insurance and Occupational Pensions Authority.

6. Banks need to be recapitalized swiftly after crisis • The 2008-2009 financial crisis had deepen the already unsustainable fiscal positions; the sovereign debt crisis since the 2011 summer has triggered a dangerous feedback loop. Solution :Consensus on banking package for restoring confidence • Guarantees on bank liabilities -to provide more direct support for banks in accessing term funding (as essential part of the strategy to limit deleveraging actions); • The repetition of the 2008 experience with full national discretion in the setting-up of liquidity schemes may not provide a satisfactory solution under current market conditions. Therefore a truly coordinated approach at EU-level is needed regarding entry criteria, pricing and conditions.

Capitalisation of banks : Quantitative capital target of 9 % have to be attained by 30 June 2012, based on plans agreed with national supervisors and coordinated by EBA. • National supervisory authorities, under the auspices of the EBA, must ensure that banks’ plans to strengthen capital do not lead to excessive deleveraging • Financing of capital increase: Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments. • Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained. • If necessary, national governments should provide support , and if this support is not available, recapitalisation should be funded via a loan from the EFSF in the case of EZ countries. • Any form of public support, whether at a national or EU-level , will be subject to the conditionality

Source: Bloomberg

European Banks’ Sovereign Debt Exposure (in million EUR)

The Future of Euro The policy commitment “The euro is at the core of our European project of peace, stability and prosperity. We agreed today on a comprehensive set of measures to restore confidence and address the current tensions in financial markets. These measures reflect our unwavering determination to overcome together the current difficulties and to take all the necessary steps towards a deeper economic union commensurate with our monetary union”. Euro Summit (Brussels 26 October 2011)

The Future of Euro The policy responses criticized as too little and too late • Disagreements among EZ core countries and ECB over the appropriate response; • Slow and complex EU policy-making process; • Domestic political obstacles/ number of protests and fall of many governments ; • Political resistance to providing financial support to countries in trouble/ critics opposed to the idea of rescuing countries without adequate budget discipline.

Policy measures - ECB ECB Support: • In May 2010, the ECB began buying government bonds on secondary markets in an attempt to stabilize bond yields; • The flexibility in its short-term refinancing operations was increased (accepting the securities, including government bonds, with lower credit ratings). • Long-term refinancing operations (LTRO): • In December 2011, providing loans to more than 500 Eurozone banks, totaling €489 billion • In February 2012, which was even bigger, totaling an additional €530 billion and had more than 800 banks participating.

Policy measures – Private sector involvment • Losses on Greek Bonds; The biggest sovereign-debt restructuring ever, covering €206 billion of debt, holders of €172 billion of bonds agreed. Collective-action clauses boost the participation to €197 billion, 96% of the total, triggering credit default swaps. With this, Greece gets its second bailout.

The Future of Euro Possible only if: • The policymakers address the underlying causes – past and future imbalances in the EZ; • Fiscal consolidation in EZ and painful structural reform in the periphery are successfully completed; • For the EZ crisis to be over (in the absence of Eurobonds or fiscal transfers), some of Europe’s debt would need to be written down; • The sovereign banking feedback loop need to be broken and • The EZ would need to have a credible growth strategy going forward.

THANK YOU!

The lessons/ policy responses and the future of the euro