In the six years since France and Germany contemptuously thumbed their noses at its budgetary disciplines, the stability and growth pact has been something of a laughing-stock. It has been ignored even more since the global economic disaster, which has shredded even the best-laid budget plans drawn up by national governments.
Paradoxically, however, this might be the time to restore the pact’s standing.
Why now? Because a new ingredient has been thrown into the fiscal pot, a disciplinary force that could underpin the pact’s influence – the power of frightened financial markets.
The European Commission has forecast that 26 of the 27 EU member states, including all 16 members of the single currency, will next year breach the pact’s deficit ceiling of 3% of gross domestic product (GDP). The pact’s target for the ratio of public debt to GDP is 60% and below, but in 2010, the Commission says, the eurozone debt ratio will be 88%. Greece’s debt is predicted to be upward of 135% of GDP in 2011.
Financial markets were awakened on 25 November to the dangers of such debt by Dubai’s effective of default on more than $26 billion (€17.6bn) of debt issued by a state-controlled investment company. Investors are now taking the risks attached to government and government-related debt much more seriously. Hence the financial markets’ reaction to the budgetary debacle emerging in Greece. Deutsche Bank’s Thomas Mayer said that Greece is “side-stepping the much-needed tough [budgetary] action”. Greece now needs to pay up to two full percentage points more to borrow money, through bonds, than Germany does.
Through most of the period since the launch of the single currency in 1999, interest rates on all eurozone government bonds have bunched together, giving the lie to those economists who predicted that financial market pressures would exercise a disciplinary force on countries by discriminating against those following feckless fiscal policies.
But rates are now diverging. The divergences are not limited to the eurozone. Last week, it was possible to buy credit default protection for the UK’s giant oil company BP more cheaply than for the country’s sterling bonds. The UK’s budget deficit next year is forecast by the Commission to be 12.9% – higher even than Greece’s 12.2%. The investment bank Morgan Stanley has warned that if the forthcoming UK general election results in a ‘hung’ parliament, so torpedoing early prospects for desperately needed budgetary consolidation, credit-rating agencies could remove the UK’s prized AAA credit rating and, therefore, send the cost of government borrowing soaring.
The reasons for the sudden turnaround in investors’ perceptions are various. One is mounting evidence that the era of super-cheap money is coming to an end. The meeting last week of the European Central Bank’s governing council signalled that it would be withdrawing crisis-induced liquidity infusions “at a somewhat quicker pace” than expected, as Barclays Capital’s European Central Bank-watcher Julian Callow put it.
Investors around the world are also being asked to swallow a mountain of new government debt. A year ago Brian Coulton of Fitch Ratings predicted that 2009 would see a 45% increase in gross EU government borrowing, to almost €2 trillion. The United States is also expected to borrow $3.8 trillion (€2.6 trillion) in the 2009 financial year. The prospects for 2010 are worse. Coulton says that the “sweet spot” for raising these sorts of sums is now over, not least because of fears that such unprecedented government borrowing will spark inflation.
If Coulton is right, political leaders – like those in Athens – who are judged to be ignoring investors’ fears could face their own wake-up call, a sudden lenders’ strike.
Meanwhile, in the EU, especially the eurozone, political pressures on miscreants are intensifying.
At the meeting of EU finance ministers on 2 December, the Greek finance minister, George Papaconstantinou, was left in no doubt that his country’s behaviour would not be tolerated. French and German co-operation in the Eurogroup underpinned this message.
Eurogroup members fear that tolerance for Greece would be read as a signal to other fiscally challenged eurozone members (such as Italy) that they too can pay mere lip-service to taking control of their debts and deficits. They are therefore taking a hard line.
The EU had already sent a strong message about economic discipline to its members when, with an eye on the future, it forced troubled eastern European member states to turn for help to the International Monetary Fund in Washington, not just to Brussels.
If Greece does not put its fiscal house in order fast, credit-rating agencies will further cut their rating on the country. On Tuesday (8 December) Fitch lowered its rating from A- to BBB+. This could have an adverse knock-on effect on the cost of borrowing for Greece’s deeply troubled banks. Nicholas Heinen of Deutsche Bank Research says that Greek banks could come under pressure through an associated worsening of their refinancing terms with the European Central Bank. That, in turn, would intensify the Greek government’s difficulties.
That is discipline. In today’s changed economic circumstances, it seems that recalcitrant governments are likely to face the punitive powers of financial markets before the uncertain sanctions of the stability and growth pact’s ‘corrective’ arm are applied. In 2005, the pact was revised; now, with financial markets queasy at the size of public debt, EU states have a chance to restore its credibility.
Stewart Fleming is a freelance journalist based in London.
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