Markets are holding their breath as the leaders of the European Union and 17 eurozone member states meet on Wednesday to try to thrash out the details of a plan to end the ongoing sovereign debt crisis.
Leaders need to agree on a series of financial and economic measures, including bailout measures and structural reforms in Greece and Italy, the recapitalisation of large sections of the European banking sector, the scale and scope of current and future stability mechanisms and the role of the European Central Bank.
At stake, many commentators have said, is the future of the euro.
Markets have not given leaders a vote of confidence. On Wednesday, yields on French and Italian sovereign debt – the interest that the countries must pay on their debt – remained high, suggesting that investors do not believe that a comprehensive plan will emerge.
As well as being an indicator of confidence, higher yields worsen the already unsustainable levels of debt in struggling economies.
“Such continued weakness in areas where a rally is needed most will probably help ensure that today's is not the last summit that is needed to 'finally' solve the euro crisis,” Deutsche Bank strategist Jim Reid wrote in a note to clients on Wednesday.
James Hughes, senior market analyst at Alpari UK, said that fatigue over rolling deadlines was creeping in, and that markets were unconvinced about the chance of an imminent resolution.
“Everyone is thinking exactly the same thing. The headlines this morning are laughable,” Hughes said. “All of them have said: ‘EU leaders ready to agree plan’. If I’ve seen that once, I’ve seen 50 times over the last three months. Everyone is full of scepticism about what’s going on at the moment.”
The route to Brussels has verged on chaotic. Yesterday, a meeting of the Ecofin group of European finance ministers was cancelled, after policymakers failed to agree on an agenda.
The route to Brussels has verged on chaotic. On Tuesday, a meeting of the Ecofin group of European finance ministers was cancelled after policymakers failed to agree on an agenda.
The run-up to the meeting has been hit by public disagreements over the continued use of ECB funding in supporting sovereign bonds from struggling eurozone economies. The central bank has nearly unlimited liquidity, as it is able to print new money, but to do so would introduce new inflationary pressures to a region where growth is already slow and slowing. The German government opposes the idea.
It is Germany, the eurozone’s largest economy and its most stable, which is likely to have to carry the heaviest financial burden.
German fiscal discipline and management of its debt mean that it is in a far stronger position than its neighbours. The economy benefited from the adoption of the euro, as peripheral countries lost their ability to competitively devalue their currencies against the deutschmark. However, the German government is unwilling to finance the fiscal imprudence of Southern Europe indefinitely.
As Baron Roger Liddle, chairman of the Policy Network and Tony Blair’s former adviser on Europe, told the Huffington Post UK: “I think that you’ve got to be understanding of the position that the Germans take. It isn’t reasonable to ask the German taxpayer to underwrite everyone else’s debts unless there’s some binding limit on how much they borrow.”
Germany has also clashed with the French over levels of the “haircut” needed on Greek sovereign debt. Under a voluntary agreement, the private sector had agreed to take a 21 per cent cut in the value of their holdings, but that is expected to be increased, voluntarily or otherwise. Greece’s ability to repay is seriously in question, after struggling to make reforms to its economy, and after growth figures came in under target.
The German position has been that the private sector should bear the brunt of the losses, backed by publically financed bank recapitalisation to limit the impact to the real economy. France, whose banks are more exposed to Greek debt, wants the public purse to carry more of the burden of haircuts in the first instance.
Markets will be looking for clarity on the source of the cash for recapitalising banks – through leverage of the European Financial Stability Facility (EFSF) or otherwise, and to finally get clarity on the scale of write-downs on Greek debt Hughes said. The latter will be punishing, but ultimately, markets prefer clarity to uncertainty.
“This is a big thing - where is the money going to come from? It’s all well and good to say we want the banks to raise €100 billion to recapitalise and guard against any new issues, but where that’s going to come from is what we want to know,” he said. “[The haircuts on Greek debt] are probably the biggest issue… Germany wants 50 or 60% write-downs. That’s going to be tough to agree but pretty much imperative.”
Adding to the market noise, unconfirmed rumours that the Berlusconi government in Italy is on the verge of collapse circulated on Wednesday morning. Italy’s intransigence on economic reform despite slowing growth and mounting debt levels has caused enormous frustration in Germany. Last year, Italy’s debt came to 116% of its GDP, and Italian bond yields have been rising to unsustainable levels.
Many blame the incoherence of Berlusconi’s cabinet and failures in his personal relationship with key members of his government, notably his finance minister, Giulio Tremonti.
Replacing the scandal-prone and increasingly unpopular Berlusconi with a more reform-minded leader might have improved confidence in the ability of the eurozone’s third-largest economy to return to fiscal sustainability.
Confidence that a consensus can be found between the various overlapping interests seems to be waning.
In the longer term, there is an acceptance that whatever plan emerges from the summit, it will not be grand enough to fully resolve the structural issues within the eurozone. That would mean greater fiscal and economic integration, greater transfer of sovereignty to policymakers in Brussels and ultimately, enforcement mechanisms to keep all member states’ debt levels under control.