A YEAR after the world’s financial system came close to collapse, EU finance ministers and central bank chiefs are working on a framework for the withdrawal of the extraordinary fiscal and monetary interventions that helped contain the meltdown.
Amid uncertainty about the force of the tentative recovery under way in major euro zone economies such as France and Germany, any system they agree at their informal meetings is unlikely to be deployed before 2011. Their efforts, however, are designed to set out a path for a return to normality under common rules when the world’s biggest peacetime fiscal expansion eventually comes to an end.
The scale of the challenge can be seen in estimates that as many as 20 of the 27 EU members will soon be in breach of the all-important threshold of 3 per cent of gross domestic product (GDP). In the EU at large, the debt-to-GDP ratio is projected to rise to nearly 80 per cent next year from 60 per cent in 2008 and would rise to some 100 per cent by 2015 if policies were not changed.
Whatever about the eventual timing, turning to exit strategies at this point sends out a signal of confidence to consumers and markets that the crisis is being overcome. While no government wishes to undermine progress by pulling back their stimulus efforts too soon, failure to do so could store up greater problems for the future.
Yet the process, which will involve large amounts of budgetary pain, will bring potential for political risk. We need look no further than the political difficulties Minister for Finance Brian Lenihan faces to see that. With unions in uproar over looming cuts and public anger at the Government palpable, the kind of difficulties Lenihan faces could well be encountered by his fellow ministers as they move to unwind their respective stimulus plans.
Lenihan did not introduce a stimulus package per se when the domestic economy went into drastic reverse, but his efforts to exercise control over the mammoth scale of public borrowing are fraught with trouble. He has already taken €8.l billion from the economy this year in tax hikes and cutbacks, but must find another €4 billion in 2010 under a five-year deal with the European Commission to bring the deficit back within 3 per cent of GDP.
At the same time, Ireland’s inability to raise money with 10-year maturity or five-year maturity earlier this year shows exactly what happens when international markets lose confidence in a sovereign debt issuer.
The German argument that any failure to plan exit strategies now would be punished by the markets flows from such realities.
If bond investors were not reassured that governments will cut their borrowing after the recovery, they would face higher interest rates. Thus the push for an exit strategy by Sweden’s EU presidency was greeted as common sense.
“From an ECB point of view, it is important to do what is necessary to exit as soon as possible,” said European Central Bank president Jean-Claude Trichet.
“It is important in our view that it starts as soon as the recovery starts. It is something which is essential for the recovery itself.”
The clear sense at present, however, is that recovery is not well enough entrenched to start down that path right away.
“The recovery of the financial sector in most countries has not yet reached the point when it is time to withdraw support,” said a discussion paper prepared by Swedish finance minister Anders Borg.
“Despite some signs of stabilisation, the restoration of the financial system, particularly the need to clean up banks’ balance sheets, remains an immediate priority. Failure to do so would risk putting the EU economy on a downward spiral, once the stimulative impulse of recent expansionary policies fades out.”
As if to confirm that the nascent turnaround in France and Germany has yet to arrest the overall decline, new figures released yesterday showed euro-zone unemployment rising to a 10-year high of 9.6 per cent in August. European Commission forecasts suggest the rate is set to rise to 11.5 per cent next year.
In addition, EU economic and monetary affairs commission Joaquin Almunia said Europe’s potential growth rate has fallen to 1 per cent from 2 per cent as a result of the crisis. This is leading to a renewed push for labour market and other structural reforms.
“We consider that to counter this lower potential growth we need to strengthen the efforts and the field of structural reforms, not only to have well-defined exit strategies for the consolidation of our public finances – for the sustainability of our public finances in the aftermath of this financial crisis,” Mr Almunia said.
“The moment to design and to agree to what we consider should be an exit strategy is now . . these should be agreed as soon as possible, but the moment for implementing these strategies will come once recovery takes hold.”
Crucial at this point is the forthcoming commission forecast for economic growth in 2011, expected early next month.
A positive assessment could mean the great unwinding starts sooner than later.
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