‘Many believe what we are doing in Europe is new. It isn’t’ – Klaus Regling
From 80s Latin America to 90s Asia, economic history is filled with examples of the crisis-reform-growth cycle, says ESM chief
Klaus Regling, chief executive officer of the European Stability Mechanism. Photograph: Graham Crouch/Bloomberg via Getty Images
Amidst the vast expanse of Luxembourg’s gleaming financial and European district, a new building has quietly taken its place.
The European Stability Mechanism is one of the EU’s newest, and fastest-growing institutions. A child of the financial crisis, the fund evolved from its precursor, the European Financial Stability Facility (EFSF), and was officially established as the euro zone’s rescue fund last September.
Sitting in his second-floor office, ESM chief executive Klaus Regling is just back from Brazil, meeting potential investors. Regling spends much of his time on the road, showcasing the ESM’s investment story. The fund has seen solid demand for its regular short-term debt issuance and will commence long-term bond issuance in the autumn.
The ESM chief also knows a thing or two about Ireland. Together with Max Watson, he wrote one of the earliest government-commissioned reports on Ireland’s banking crisis in 2009. Ireland is once again back in the spotlight as it becomes the first euro zone country to exit a European bailout programme. International markets are watching closely.
Like most key euro zone figures, Regling is full of praise for Ireland’s progress. “Ten-year government bonds for Ireland now have a yield in the secondary market of below 4 per cent. That’s a very reasonable rate and in that sense Ireland is already a success story and very close to normal market conditions,” he says.
When it comes to Ireland’s need for a precautionary credit line to ease its passage back to full private market funding, he is less forthcoming. “Let’s see in a few months’ time where the country stands [...]in principle the instrument is available.”
Any precautionary credit line would be of a minimum 12-month duration which could be extended twice by six months, he says, though he declines to give any hints on any attached conditions.
The Irish Government is understood to be reluctant to sign up to any precautionary programme that might involve onerous conditions. A final decision is likely during the troika visit in October, a period that will coincide with preparations on the 2014 budget.
Coalition tensions have already emerged over the degree of flexibility the Government will have. How important is it that Ireland sticks to its target of a €3.1 billion fiscal adjustment in October?
“I think that is certainly one of the elements markets are looking at. They want to know how the budgetary developments are [...]I think that at the end of the 11th review, it was very clear that another €3.1 billion fiscal adjustment as foreseen under current rules and as previously agreed with the authorities is the important next step,” Regling says.
He emphasises that any application for a precautionary credit line needs the approval of the euro group, the euro zone’s 17 finance ministers. Is adherence to the €3.1 billion target in the budget necessary to guarantee that support?
“I don’t know what the conditions would be, but if the agreed target were not reached I’m sure that would not be well received.” Any precautionary credit line would be of a minimum 12-month duration, he said.
As for Ireland’s eligibility for the European Central Bank’s bond-buying programme, Regling questions whether Ireland has a need for outright monetary transactions (OMT), the ECB’s programme to buy bonds of bailout countries. “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,” he says.
He also dismisses a suggestion that the ESM could take Ireland’s problem tracker mortgages off banks’ balance sheets.
“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.”
But while the ESM may not be in a position to involve itself in Ireland’s mortgage issues, the fund and its predecessor have been key players in Ireland’s EU-IMF programme, contributing to Ireland’s funding needs both through its regular disbursement of funds through the EU-IMF programme and the decision earlier this year to extend the maturity of Ireland’s EFSF and ESM bailout loans.
It is also central to the last outstanding option for further bank debt relief for Ireland – ESM direct bank recapitalisation. Last month the euro zone finance ministers agreed to look at retroactive applications on a case by case basis, despite strong resistance to the idea from some member states. Are Irish people misguided in their belief that they are entitled to retroactive debt relief, particularly in light of the fact the European policy shifts towards pushing the burden of future bank bailouts away from taxpayers and on to private creditors was not available to Ireland at the time of the bailout?
“It is easy to say it would help, but the euro group communique said that the decision to use the direct bank recapitalisation instrument retroactively would be taken on a case-by-case basis and by mutual agreement. It will be up to the political level in the euro area to decide how that is interpreted. At the same time I hope Ireland realises that a lot of help has been provided, because the financing we provided, that the IMF has been providing, and also third countries have provided over the last 2½ years comes at very low interest rates, so Ireland benefits from this low interest rate. Our own lending is provided at less than 1.5 per cent, for instance, so that’s a big benefit for Ireland as it is for other countries that borrow from the EFSF. There are also special arrangements with the ECB that have been found, where the Irish banking sector benefits greatly. We know that the crisis has put a huge burden on the Irish taxpayer, the Irish population, but there has also been a lot of solidarity from Europe and the international partners.”
On the issue of the looming European bank tests scheduled for next year, Regling is optimistic. “I think it’s really important to do these reviews, these stress tests, see if there are problems. My expectation is that there are not too many, but it’s very important to really dig into it in a credible way so that these concerns in markets once and for all can be put to rest.”
In the event that capital is required, the ESM could contribute, he says, though he stresses that the hope is that no public money will be used as envisaged by the new bank wind-down rules that are being worked out in the bank resolution and recovery directive.
Like many of his peers, Regling sees the EU’s ongoing banking union project as vital, not only for preventing future bank crises, but as a way of addressing the problem of market fragmentation which has seen substantial interest rate spreads between peripheral and core countries, an issue regularly highlighted by the ECB. “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.”
What of the suggestion by Germany and others that the ESM would be a more suitable institution than the European Commission to run the proposed new European bank resolution authority, the Single Resolution Mechanism (SRM)?
“I’m not lobbying for that. There’s not much synergy that I can see for the ESM to play the SRM role. It’s different with the single resolution fund which will also be needed to collect the money from the banking industry. There the ESM can probably offer some synergies, but that is only a very small aspect of the whole operation. “
Having held senior economic roles in the German finance ministry, the European commission and the IMF, where he spent 10 years working in Washington and Jakarta, Regling is a heavy hitter in terms of economic experience. His CV places him apart from most of the political leaders that are driving euro zone financial policy. In light of this background, his recent suggestion that his former employers in Washington should not be part of future euro zone rescues raised some eyebrows.
European Commissioner Viviane Reding continued the theme last week, describing the IMF’s involvement in European rescues as “an emergency solution”. Regling plays down the import of the remarks. “I said what also 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.”
As a long-term institutional economist, Regling is also a strong defender of the so-called policy of austerity that has been much criticised of late. “Without the fiscal consolidation measures we would not have seen stabilisation of markets,” he says emphatically.
“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 80s and 90s . It happened in the Asian crisis in the 90s. 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.”
But is this not the first time the policy has been applied to a currency union such as the euro zone?
“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.”
Ultimately, his remarks suggest he believes the currency union is not to blame.
“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.”
For Regling, fiscal consolidation combined with structural economic reforms is still the only game in town.
CV Klaus Regling
Position: Managing director of the European Stability Mechanism
Something that might surprise: He has an Irish son-in-law
Something that you’d expect: He has a top-notch economic background, having served as director general for economic and financial affairs at the European Commission between 2001-2008. He also spent 10 years working with the IMF in Washington and Jakarta, and a decade with the German ministry of finance. He was rumoured to have been a possible successor to Jean-Claude Trichet as head of the European Central Bank.