“The future of the euro area, and Greece”
Yannis Stournaras, Governor of the Bank of Greece
Seven years after the outbreak of the crisis with Greece in the eye of the storm, the situation has improved a lot, the major imbalances have been corrected, and the euro area economy is recovering. Nevertheless, no one can claim that all problems have been resolved or that a new crisis can be ruled out.
Once the elections in Germany are over and a government is formed, it will perhaps be an appropriate time to start a discussion on further improving the euro area architecture. Seven years after the onset of the crisis, we are wise enough to understand better than before the mistakes made, to assess the measures taken and, most importantly, to plan more effectively the next steps in order to shield the euro area. These steps, however, must be planned now. The view that we should wait for a more appropriate time is wrong and risky. The next crisis, if and when it arrives, must not find us unprepared.
The economic and social performance of the euro area needs to be improved. We need a far-reaching and ambitious, yet realistic, approach so that we can turn the monetary union into a more complete economic and monetary union that will possess adequate tools and resources to deal with unanticipated crises, as well as long-term governance rules. Failing to act now would put at risk the single currency, one of the most ambitious political and economic projects in our continent since nation-states emerged.
A key finding from the crisis is that euro area membership has stripped Member States of some policy instruments without replacing them with others, centralised at the euro area level. Moreover, the euro area lacked a crisis management mechanism.
It is true that major steps have been taken during these seven years to improve the euro area; we must design the future of the euro, building on and completing these steps: the provision of intergovernmental loans, especially to Greece; the establishment of the European Stability Mechanism and the recourse of Member States in crisis to that mechanism; the (still incomplete) banking union; macro-prudential supervision of the financial system; and major initiatives by the European Central Bank (ECB) aimed to safeguard financial stability. Also, at the national level, drastic fiscal and structural measures have been taken in order to eliminate macroeconomic imbalances, restore competitiveness and strengthen the capital adequacy of the banking system.
Given that the ECB cannot continue to shoulder the burden of stabilising the euro area almost on its own (“the only game in town”) and to keep monetary policy too loose indefinitely, the next steps to strengthen the euro area architecture should include: (a) reinforcement of the macroeconomic rebalancing mechanisms, which must operate symmetrically; (b) enhancement of mechanisms for sharing risks as well as responsibilities; (c) reforms to boost economic growth, reduce unemployment and increase the resilience of the euro to future crises; (d) increased accountability of European institutions to the European Parliament.
The economic rebalancing mechanisms within the euro area should be reinforced and, in particular, should operate symmetrically, i.e. both for Member States with external deficits and for Member States with external surpluses. To this end, it must be ensured, as is already provided for in European Union rules (Macroeconomic Imbalances Procedure), that the upper and lower bounds for current accounts are adhered to, in particular by Member States that accumulate large and continuous current account surpluses. This is so because, unlike the Member States that had large deficits and eliminated them, the steady and increasing accumulation of surpluses in some Member States has hampered the adjustment efforts of the deficit ones, causing a deeper recession and higher unemployment in them.
Risk-sharing within the euro area should be strengthened, for example in line with the recommendations of the 2015 Five Presidents’ Report, or as specified in the European Commission’s reflection paper on the deepening of the economic and monetary union (May 2017), or other proposals, such as those published by the Jacques Delors Institute in autumn 2016, that are based both on the experience from the crisis and on a number of important academic analyses. Private sector risk-sharing can be achieved through actions that will lead to a genuine financial union with fully integrated financial markets, including capital markets. These actions involve the completion of the Banking Union through the establishment of a European Deposit Insurance Scheme and a single rulebook to govern both the operation and resolution of banks.
Promoting a genuine Capital Markets Union can be achieved through legislative changes that will require harmonization with best practices regarding securitisation, accounting, insolvency law, company law, as well as property rights.
In addition to strengthening the private sector risk-sharing channels, it is necessary to create a centralised fiscal stabilisation tool in the euro area in order to absorb any strong macroeconomic shocks, i.e. there is a need for a public sector risk-sharing mechanism. This tool will provide effective protection against asymmetric shocks triggered by regional disturbances. While there is currently no willingness to set up a fiscal union, there are realistic alternative ways to move forward with the creation of a central fiscal stabilisation tool. For example, drawing on the experience of the already existing European Fund for Strategic Investments (Juncker Plan), it is possible to reach an agreement that will promote reforms in exchange for investment projects financed through a common fund of European resources. These resources could come either from an intergovernmental investment fund or from the EU budget. There has also been a proposal regarding the issuance of European “safe” bonds (ESBies) and, later on, Eurobonds by the European Stability Mechanism under the appropriate terms and when the conditions allow so. In addition, the establishment of a European unemployment insurance scheme could be considered.
At a final stage, the European Stability Mechanism could be transformed into a fully-fledged European Monetary Fund that would act as lender of last resort for Member States. Governments facing financial distress and difficulties in accessing markets would be able to borrow from the Fund, subject to appropriate conditionality.
Greater risk-sharing, e.g. through the issuance of Eurobonds, could be better received if accompanied by a greater sharing of responsibilities. In this context, it has been proposed to appoint a Euro Area Finance Minister with a veto right over national budgets and accountable to the European Parliament.
Over the last seven years, despite the mistakes and backtracking that largely explain why Greece is the only euro area country that still remains in a programme, an unprecedented, in the history of the European Union and the OECD, correction of macroeconomic imbalances has been achieved. The large “twin” deficits (fiscal and external) of 2009 have been eliminated. Labour cost competitiveness has improved by 27% and price competitiveness, in terms of GDP deflator, by 20%. Many structural reforms have been implemented in labour and product markets as well as in public administration. The banking system, while it has a high non-performing loan ratio, mainly as a result of the crisis, also has relatively high loan-loss provisions and capital adequacy ratios.
Furthermore, a strong political consensus has been formed in favour of keeping Greece in the euro area. In their majority, Greek political parties are not only in favour of the euro, but also have supported measures in the Parliament, sometimes with heavy social cost, to ensure that Greece remains in the euro area.
These measures have increased Greece’s credibility towards the euro area, which, as a matter of fact, has been achieved through the significant sacrifices of the Greek people after 2010. These sacrifices imply taking responsibility for the risks assumed by the euro area and, to a much lesser extent, the rest of the international community through the IMF, as a result of the loans granted to Greece.
However, we still have a way to go before Greece can stand on its own feet without help and regain the trust of financial markets after the end of the programme, in August 2018. This will happen if the country can achieve a credit rating enabling it to refinance its debt at interest rates compatible with debt sustainability and if banks have appropriate and adequate collateral to have full access to the ECB’s refinancing operations (and not only to ELA).
The first and crucial step in this direction is the timely conclusion of the third review. This will further improve confidence and the possibility of sustainable market access. The fact that there is still a lot to be done in the areas of privatisations and structural reforms means that there is considerable room for increasing the potential output of the economy on a permanent basis. What has been achieved over the past seven years is only the beginning of a new growth model based on sound fundamentals and higher competitiveness. For example, we further need more ownership of privatisations and more public-private partnerships, even in areas that used to be totally taboo, such as social security, healthcare, education; several other reforms, e.g. in the energy market, the market for goods and services, and in certain professions, in order to increase productivity and reduce the costs for consumers; an overhauling of public sector structures; measures to reduce red tape in public administration; measures to speed up judicial proceedings; full respect for the independence of institutions; encouraging and providing incentives for private sector cooperation with universities and research institutes, in order to promote innovation and the transition to a knowledge-based economy; and, of course, tackling the large volume of non-performing loans and the problem of strategic defaulters, that hamper not only the effort to restore a sound banking system but also the growth of the Greek economy. Last but not least, a great challenge is attracting foreign direct investment to fill the large investment gap, focusing on the most productive sectors of the economy.
Second, there is the issue of debt sustainability. As agreed in the Eurogroup, the partners are expected to take an appropriate initiative, if this is deemed necessary. The Bank of Greece has already made specific proposals for a mild debt restructuring, e.g. by lengthening the weighted average maturity of interest payments on EFSF loans by at least 8.5 years. The calculations show that this could make a significant contribution to debt sustainability, even if primary general government surpluses were to remain at 3.5% of GDP until 2020 only (rather than until 2022 as envisaged in the agreement) and fall to 2.0% thereafter. These two proposals, if adopted, would certainly support both the recovery of the economy and the country’s creditworthiness, especially if the fiscal space thereby created, estimated at 1.5% of GDP, is used to reduce taxes on labour and capital. This mild debt reprofiling proposal is vital for Greece, while it involves only a negligible cost for its partners. The above will pave the way to the inclusion of Greek government bonds in the ECB's quantitative easing programme, which in turn will facilitate sustainable market access and further support economic recovery. This will set in motion a new virtuous circle that will signal investor confidence in Greece's economic prospects and will encourage the return of more deposits to banks, a return to financial markets after the end of the current programme, and, eventually, the full abolition of capital controls.
Third, there is the question of economic policy credibility in the long run, which would ensure unimpeded access to financial markets and avoid the repetition of past mistakes that brought Greece to the epicenter of the euro area crisis in 2010. It is clear that a credible commitment is required of all the Greek political parties that are in favour of Greece remaining in the euro area. Mario Draghi, the ECB President, who in July 2012, when centrifugal forces stemming from the Greek crisis threatened the euro area, said in London the historical phrase “the ECB will do whatever it takes”, set a good example that the leaders of Greek political parties need to follow if and when this is deemed necessary.
In the interwar period, Stefan Zweig, who probably felt what was coming, wrote and read to his audience a plea to Europeans, a visionary and ambitious text, far ahead of his time but also of our own time, addressed to his contemporary European leaders. I am confident that today’s euro area leaders, who will sooner or later sit at the table of negotiations to discuss the euro area’s future, will read it again before they start discussions.