EU sovereign debt crisis: Hurling towards the abyss of recession

Arguably the world’s most powerful leader, Barak Obama, underscored that the Eurozone crisis is “scaring the world”. It comes as no surprise then that his Treasury Secretary Tim Geithner heads the international clamour for more action to solve the burgeoning sovereign debt problem that has dominated financial markets in recent times.

George Osborne, Britain’s current Chancellor of the Exchequer, draws an intimate connection between regional growth and national development, emphasising that resolving the Euro crisis is the primary action that would boost the British economy – much more than any other measure undertaken by the Government.

Britain’s former Prime Minister and Chancellor Gordon Brown, however, crystallises the financial crisis as a problem of currency and of lending institutions (banks), stating that the euro cannot sustain itself in its current form and that European banks are “close to insolvency”.

According to a recent edition of the Wall Street Journal, European nations are “flirting with recession” and cannot even seem to agree on how to climb out from under their mounting pile of debt. Such scathing commentary warrants a “bold and immediate” action plan, previously mandated by the European Central Bank as “essential” in order to prevent the avalanche of recession amongst European Nations, and indeed the world at large.

Greece

Greece stands at the centre of unfolding financial gloom and economic turbulence. Despite growing external pressure and numerous pledges of a substantial bailout package, the Greek Government has admitted that it will fail to reach its target of reducing the budget deficit to 7.6% of its GDP in 2011-2012. Ominous signs indeed for many Eurozone nations staring down the barrel of fiscal impoverishment.

One must not forget that sovereign debt, as Government debt, lays its claim on each and every citizen by virtue of nationality and residence. In reality, it is the Greek people – of all classes – and not the Greek Government, who will be asked to toil in the coming months and years to fill the widening deficit in income/revenue, in the name of economic development and national interest.

The ever-present threat is that Greece remains the current sticking point, and can easily become the stereotype model for other European nations with wobbling economies, mainly Ireland, Portugal, Spain and Italy.

European economic powerhouses like Germany and France – propellers of the 440 Billion Euro “rescue” fund, of which Euros 8 billion will be streamlined into the Greek economy, might not be in a stable position to procure another bailout package to salvage floundering Eurozone economies in the future.

According to Gordon Brown, even the current European Financial Stability Facility (the rescue fund) falls drastically short of about two or three trillion euros that are ideally needed to rejuvenate the regional economy. However, macroeconomic consultants have remarked that the promise of an aid package has contributed towards reducing the threat of a near catastrophe in the Eurozone, although it does nothing to address the fundamental problems facing Greece, and is unlikely to bring an end to the recent indicators of economic gloom in bigger market economies like Italy and Spain.

Meanwhile, analytical economic data has evidenced that the weakness of activity in the peripheral economies is starting to spread to the core, with even Germany threatening to lose steam. With gross domestic production and economic growth likely to slow further – given the wider effects of global recession crippling even the US, and the fiscal crisis continuing its overwhelming reach – doubts and insecurities over the future of a single dominant world currency (like the euro) and a cohesive regional lending policy are likely to grow.

Falling in line

Belonging to the European Union family inevitably means that Greece has to adhere to the dictates of the European Central Bank, irrespective of how harsh or rigid the bank’s policies and initiatives are. The allure of being part of a revolutionary supra-national political entity like the European Union means that countries like Greece enjoy the fruits of a broad and collectively regionalised fiscal policy.

George Osborne (the British Chancellor) voices his support of a single, collective European voice in monetary decision making, emphasising that the logic of monetary union leads directly to fiscal union, although his own country has had teething problems in the past with ratifying the euro domestically, given its “dualist” nature.

However, when the trappings of regional harmony and greater economic development fades with time, tough measures and a tougher attitude takes over, often sanctioned by economically hierarchical nations in the union along with the European Central Bank.

Steep and stringent taxation laws stimulate Government earning, garnering much needed income/revenue for State coffers. Greece is no exception to this rule, with Greek Prime Minister George Papandreou insisting that his country can and will resolve the crisis through tough austerity measures in the future.

Public outcry

However, the truth of the matter is that when taxation becomes suffocating, it results in social and political instability and civil unrest, which in turn adversely impacts the economy on the whole, reducing consumption and downsizing growth.

The recent public protests in Athens, where employees from all modes of public transport – including subway and bus drivers – customs officials and tax collectors showed their displeasure, almost crippling the nation with strikes is a clear-cut example of this.

Will nations like Greece posses a strong political will, clear vision and steely leadership to implement austerity measures ‘to the T,’ especially in the face of public rebellion and internal party discord? Indeed, the very heart of Government will be tested severely. Will they bend to the demands of the bailout terms or respect the beseeching actions of the masses? This is the key question facing the political leadership in Greece.

The recent actions of the Greek Prime Minister indicate that he will use a heavy hand in dealing with the financial crisis, guaranteeing that his country will deliver on all the austerity pledges made for its first Euros 110 billion rescue programme, which was funnelled by fellow Eurozone members and the International Monetary Fund. This public assurance comes in the wake of admitting that “drastic measures have had a dramatic impact on the living standard of our citizens”.

Many analysts fear that heightened austerity measures will bring about open revolt within the ruling political party, the Socialist Party. David Lea, an independent risk analyst/consultant, opines that only early elections can prevent such an in-house discord, but that too would prove detrimental to the country, especially given Government expenditure during the election process.

Adopting further austerity measures will have to be voted on in the Greek Parliament, and without such legislative approval, Greece will be prevented from securing further funding from its creditors. Thus spins the vicious cycle.

Dependency syndrome

Another common austerity measure is for Governments to initiate short-term freezes on domestic expenditure and capital spending/investment, in order to curb the haemorrhaging of money spent on infrastructural and social development, much to the detriment of nation-building and greater political conscience.

At this juncture, Greece will do anything to pacify its big brothers heading the European Union, in order to be injected with life-giving financial aid. But can the country sustain the momentum once the Euros 8 billion have been dispersed?

If Greece cannot redeem itself in the eyes of the European Union and the world, it will deal a fatal blow to European regional development, especially since the European Union has long been hailed as a model of regional economic and political cooperation, even amongst feebly active SAARC countries.

If the union crashes due to the failures imminent in the post-bailout plan period, then it will herald a mass-scale global meltdown and encourage a terrifying economic fear psychosis, adversely affecting global share markets, and stimulating greater volatility and vulnerability. Even key sectors in Sri Lanka are at risk, given the ‘dependency syndrome’ of the exports and tourism sectors, due to the outreach of globalisation.

Borrowing against the fund

Talks of maximising the final amount of the rescue fund by borrowing against it has also preoccupied the minds of union leaders, although it conflicts directly with Treaty law – an express and direct form of ratified laws governing the union.

Borrowing against the fund could prove beneficial to investors in that it could cover their losses and the money can be used to buy and/or back debt on the market or even inject capital into banks that fast becoming the most threatened entities in this financial crisis. It could also be used to build a protective wall around larger, more vulnerable Eurozone nations, like Italy and Spain, in the near future.

Such a decision would provide trillions of euros of much-needed ammunition to rescue floundering banks and Governments, but would warrant the unconditional consensus of all 17 Eurozone legislatures. This idea seems unlikely to materialise given Germany’s staunch opposition, and as the largest and most powerful Eurozone economy, it can dismiss cries that the “embryo” package of Euros 440 billion it helped fund is grossly insufficient and fails as a rescue fund even before being implemented.

The hope of financial intervention from emerging market countries or Asian powerhouses like China, which has US$ 3.2 trillion in foreign reserves, seems far-stretched for now, although most of them rely on Europe as a key customer for exports. Most of these “new” economies have reiterated that Europe would have to take the first step in resolving their ‘own problem,’ with China even elaborating that the country cannot simply save other nations facing crises. “We are not saviours. We have to save ourselves,” seems the current mantra.

European banking crisis

The sovereign debt crisis in the Eurozone has also brought to light the European banking crisis. There is indeed a close interconnection. Bank balance sheets are stuffed full of Government bonds issued by the Eurozone states.

The prospect of defaults by Eurozone countries will inevitably cause tremors in the investment world and financial sectors. Any solution to the financial crisis will therefore have to break the “nexus between the sovereign crisis and banking distress,” states Wall Street Journal’s Money and Investment Editor Francesco Guerrera.

Stimulus packages and equity injections (similar to the Troubled Asset Relief Programme launched by the US in 2008) could prove costly. Unlike the US, the union does not have a central cash repository which could be utilised to bail out banks at random.

The only legitimate fund that the union possesses is the European Financial Stability Facility, which is currently needed to bail out Greece urgently. With its limited firepower and outreach, this fund cannot be expected to also rescue European banks, most of which have been tottering for years.

On the other hand, many banks, financial institutions and Governments have resisted the “Europeanisation” of national assets and entities. Bailing out banks is one thing, but will that tantamount to a unified continental banking system and unprecedented nationalisation (i.e., European nationality)?

The individual citizen and tax payer wouldn’t be too thrilled with such a development but will he/she welcome the fact that if dire economic conditions prevail, banks will be forced to drastically reduce their lending and a range of other financial activities, greatly undermining the broader economy and impacting livelihoods?

Stumbling block of the future

Eurozone Finance ministers recently delayed making a decision on giving Greece its next instalment of bailout cash, after the country stated publicly that it is unable to meet this year’s deficit cutting plans. This does not augur well for the survival of the European Union and its global counterparts, with major stock markets taking a tumble immediately after the cancellation of the 13 October financial meeting.

This means that Greece will now only get its next loan tranche in November 2011, although it has stated publicly that funds were needed by mid-October, in order to avoid defaulting on loans.

With the continuing dilly-dallying of key political and economic figures in the European Union over the “Greece issue,” the knowledgeable insight given by the President of the European Commission Jose Manuel Barroso sheds light on the simplest but yet crippling stumbling block of the future.

Speaking to journalists after delivering his annual report, Barroso stated: “Markets are much faster than our Governments and our Parliaments. We have to respect the rhythm of democracies, but I think in extraordinary times we must ask for an extraordinary effort.” This is the ever-elusive panacea that the world needs.

“Extraordinary” effort

But how can Governments, institutions and regional bodies conjure and implement such revolutionary, visionary measures in the face of a European meltdown, and indeed, global recession? Pray, what is the scope, in the ‘real’ world, of the “extraordinary effort” that Barroso passionately advocates?

When leading European and world banks are spiralling downwards, curbing lending and fighting for survival, when Herculean economies like China, which boasts huge foreign reserves, casually shrugs its shoulders when the time of desperation draws near, when financial decision-makers at the highest echelons of the European Union prod along without making hardcore decisions aimed at revitalising their frail economies, when Treaty law restricts fiscal measures and economic policies that could actually offer some respite to the sovereign debt crisis, when powerful economies like the US and Britain continue to fight their own financial demons while merely spewing rhetoric regarding close collaboration with Eurozone countries, when stock markets tumble and assets and reserves dwindle amidst the deepening signs of a wide spread global economic meltdown, when consumption drops and growth stagnates… how does one envision and adopt “extraordinary” measures? How does one reboot a stuttering and rusty supra-national machinery into performing at its optimal level?

Barroso’s desire still remains unanswered; disregarded... and herein lies the massive failure of the European Union.

(The writer is a Chartered Accountant. He is the Managing Director/CEO of Chemanex Plc., Chairman of The Finance PLC and Director of many other Public and Private Limited Companies in Sri Lanka and abroad. He is also a member of the Monetary Policy Consultative Committee of the Central Bank of Sri Lanka.)