Klaus Regling: “I hope Ireland realises that a lot of help has been provided”
“We know from experience that structural reforms combined with fiscal adjustment, over time leads to higher growth”
SL: It was suggested last week that the ESM could play a role in dealing with tracker mortgages in Ireland, moving tracker mortgages from bank balance sheets.
KR: I was a bit surprised because that instrument doesn’t exist at all for the ESM. And I don’t see an appetite among the euro area countries to create a new instrument.
IMF ROLE IN TROIKA
SL: You’ve mentioned before the IMF’s future role in the troika, questioned that. Vivian Reding last week said something similar...
KR: It was not similar. I said the same that the ECB and Olli Rehn have said: that we need the IMF in the troika in the short and medium term. Only in the long run one could reconsider that. So I think for the assistance programme that we have at the moment, for five countries, the IMF plays an important, complementary role that I would not question.
SL: How important is banking union and is it progressing fast enough?
KR: I think it’s the most important project we have at the moment. It’s partly to improve confidence for now, but also very important to prevent the next crisis. It’s important now because there’s good progress in the different countries in fiscal adjustment and the improvement of competitiveness where it is needed. More than half or maybe two thirds of adjustment in these two fields has happened. On the banking side we see continued problems with the renationalisation of banking. There’s a fragmentation of markets, which leads to substantial interest rate spreads, not only for the sovereigns, but for private sector borrowers in countries in the periphery compared to countries in Northern Europe. These high borrowing costs, for all borrowers, SME’s and non financial corporations in the countries in the periphery are a burden for the real economy, for the recovery of these countries.
SL: But the ECB keeps saying this, but should they do something about it then?
KR: The ECB is doing things about it by making refinancing easier, for example through the so called LTRO. But banking union is the other means through which we try to address this problem, because the different steps that comprise banking union are designed to create confidence in the market, about the sustainability, the irreversibility of monetary union. This will improve confidence in the banking system in the euro area and if we succeed in doing that, if confidence comes back, then these spreads will come down.
SL: When you say banking union, deposit insurance scheme is one plank of that and that seems to be losing support among member states significantly.
KR: That is one of the elements and probably the one that will happen last in the sequence of steps. It’s very complicated because every country has a different system, every country in the euro area has a deposit insurance scheme but the way it is set up differs from country to country. Some countries have actually accumulated money that has been sitting in a pot, others have just promises and guarantees in place, so to put all that together is very difficult.
SL: And Germany is particularly concerned?
KR: Germany has particular difficulties because inside Germany there are different schemes, three different schemes. If everything is being harmonised they would also have to be harmonised. This takes time, it cannot be done overnight.
SL: What we’re seeing now is that even though the threat of a euro zone exit has receded , bond spreads have come in, there seems to be a potentially more insidious problem of entrenched unemployment and also challenges politically. There are tensions in Portugal and Greece in implementing fiscal consolidation measures. Do you think these fiscal consolidation measures still need to be sustained, or have they worked?
KR: Without the fiscal consolidation measures we would not have seen stabilisation of markets. The spreads show it very clearly. It’s very painful for the population. That’s not a contradiction to other improved macro-economic indicators unfortunately, because labour markets always react later than the other indicators. There are very good reasons that markets have stabilised and calmed down. In this phase incomes are cut, consumption is weak, domestic demand is weak, GDP drops. This is unfortunately unavoidable. If one moves from a situation where incomes were too high, one has to move to a new equilibrium. But experience elsewhere in the world and in Europe shows that it works particularly well if these measures are combined with structural reforms. We know from experience that structural reforms combined with fiscal adjustment, over time leads to higher growth and employment.
This has been confirmed, over the last 50 years, in all the IMF programmes. Many people in Europe believe what we are doing now in Europe is completely new. It’s perhaps new for Europe, but it’s not new when you look at economic history. It happened in the Latin American debt crisis in the 80’s and 90’s . It happened in the Asian crisis in the 90’s. There’s always the same sequence. Initially incomes drop during the adjustment phase, but if this phase is combined with structural reforms, conditions are created for a period of sustainable growth afterwards.
I was just in South America last week. Brazil, for the last 5,6,7 years was one of the star performs of the world economy. They went through a very serious difficult adjustment, with high unemployment and declining incomes in the 80’s and again in the 90’s . The same happened in South Korea, Indonesia Thailand in the late 90’s, the same happened in Turkey 13, 14 years ago. This adjustment period is always difficult, but then there’s a turning point.. and all these countries that went through a difficult period ten or 20 years ago, are now performing very well.
SL: This is a different situation though because we have 17 euro zone countries, with a single currency
KR: It’s not so different. The one difference is that countries don’t have the exchange rate to adjust. That’s the reason why all these countries in the periphery have decided to cut incomes. Nominal income cuts have become a substitute for the exchange rate instrument. That is new. This has not happened in other countries, but the effect is comparable because countries like Brazil, Indonesia, Turkey had a serious devaluation of the exchange rate , subsequently followed by high inflation, so in real terms the income also fell. The effect is the same. As a result competitiveness is restored, exports are growing and the current account deficits disappear.
SL: But the effect of falling incomes has had a knock on effect on the ability to pay back private debt , for example in Ireland, the fall in income has accelerated, for example, the problem with the mortgage books.
KR: But you can do an experiment in your mind and think about what would have happened if Ireland had had its own exchange rate. It would have devalued, inflation would be much higher, interest rates would have gone up a lot in response to high inflation and weak exchange rate, so everybody with a variable mortgage would really have suffered more.
EXIT STRATEGY AND OMT
SL: In the next few months in the run up to exiting the bailout, would you like to see more aggressive, more frequent, bond issuance by the government?
KR:I cannot give advice on that. I see that Ireland like other countries has done some prefunding. That’s positive. It helps confidence in the markets. But as to whether more or less of that would be good I cannot give advice. That’s for the Irish debt office to decide.
SL: But presumably the troika is giving advice. It’s going to be a very powerful force in the next few months.
KR: Yes, but not so much in terms of debt issuance.
SL: Do you think Ireland should be eligible for OMT?
KR: Well you know what the conditions are for OMT. There has to be an ESM programme in place that allows for the possibility of primary market purchases, and then it’s up to the ECB to decide. In my view, at the current interest rate level, there’s no need for OMT at all.