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Financing the public debt in times of crisis Communication presented by Philippe Auberger Member of the General Council of the French Central Bank, Formerly budget general speaker for the French National Assembly London School of Economics October 22nd, 2010 1 Financing the public debt in times of crisis Introduction The financial crisis of 2008-2009 lead to: An increase in public deficit and debt in most developed countries Financial markets disturbances increased volatility risk aversion The most fragile and indebted countries now find it increasingly difficult to cover their financial needs Greater vulnerability – Greece is only one example among others The absence of a European solidarity mechanism which would ensure the long term financing of the public debt is severely pointed out. London School of Economics October 22nd, 2010 2 Financing the public debt in times of crisis 1. Financing the public debt is increasingly difficult a) Before the crisis, financing the public debt was relatively easy Maastricht criteria were respected Deficit < 3 % of the GDP Public debt < 60 % of the GDP Public Debt was kept stable Countries which did not comply with the Maastricht criteria, including those not part to the European Union, were firmly called to order. Hence, overruns were neither considerable nor durable. Developed countries did not face serious difficulties when trying to cover their financial needs. Such debts were much sought after by banks as basis for banking refinancing. Relative freedom when asked to choose the term London School of Economics October 22nd, 2010 3 Financing the public debt in times of crisis 1. Financing the public debt is increasingly difficult b) Since the financial crisis of 2008-2009 started, financing the public debt has become more difficult The economic downturn and the measures taken to sustain employment (automatic stabilizer, new expenses, support to banks) have sharply increased the deficit. France : deficit increases from 2.3% of GDP in 2006 to 7.5% in 2009 and 8% in 2010 The brutal increase in the deficit triggers a fast increase in public debt. France : debt went from 63.8% of GDP in 2007 to 83% in 2010 The annual appeal to financial markets to refinance the debt and cover the deficit has sharply increased. France : it went from 120 billion Euros in 2007 to 180 billion in 2010 Even if we would plan on a deficit under 3% in 2013, the decrease of the debt will be much slower than that of the deficit. London School of Economics October 22nd, 2010 4 Financing the public debt in times of crisis 1. Financing the public debt is increasingly difficult c) Difficulties in the financing are greatly concealed by the economic situation Central Banks’ policies (very low interest rates, use of unconventional measures) ensure abundant liquidity ready to be invested in “secure” debt. Thanks to the abundant liquidity, long term interest rates are low: rate < 3 % for 10-year bonds When the economic situation will brighten: • Private firms will start investing again • Central Banks, fearing inflation, will increase their intervention rate • Crowding out will occur • Greater selectivity in the subscriptions • Increase in the cost of debt • Inferred effects on the economic situation and on the restrictive budgetary policy . London School of Economics October 22nd, 2010 5 Financing the public debt in times of crisis 1. Financing the public debt is increasingly difficult d) The difficulties of Greece facing the financing of its deficit during the first semester of 2010 have illustrated: The extreme nervousness and volatility in the markets. lack of conviction in complying with ones commitments unusual role of the rating agencies That each country faces its own specific situation which is left to the discretion of the markets Example : evolution of the rate spread between France and Germany, it fluctuated between 20 basis points and 50 basis points A lack of confidence in the reliability of the mutual aid mechanism within the euro zone and an important waiting time in the implementation of policies (European Financial Stability Facility). London School of Economics October 22nd, 2010 6 Financing the public debt in times of crisis 2. A new governance of public finances appears to be necessary a) Whether or not it is to be deplored, the rating agencies’ appreciation on the straightening of the public finances and control of the debt policies cannot be ignored: Markets but also Central Banks and in particular the European Central bank already make good use of such appreciations from rating agencies Such agencies have announced that they will put under surveillance the debt of numerous countries, including those with the best marks (AAA) EU, GB, Germany, France… The fall in the marks makes the placement of debt more difficult and above all more costly Hence the need to adapt the annual and long-term planning to the expectations of the rating agencies, even if it means drastic budgetary adjustments and a severe risk of economic slowdown Should the marking fall, there will be consequences on the financing of the public sector and of the State Investments London School of Economics October 22nd, 2010 7 Financing the public debt in times of crisis 2. A new governance of public finances appears to be necessary b) The preparing of the budgetary decisions and the control of their execution are made to be discussed with the executive and legislative powers and, when needed the jurisdictional power. The terms used differ from those used in accounting with which firms, markets and rating agencies are more familiar More readability and transparency are thus required • Interlocking of the State, Social Security and Local Authorities accounts • Increasing number of changes in the revenues allocation • Numerous expenses transfers between the different entities • Difficulties when trying to obtain coherent accounts, identifying the deficits and following their evolution • Increasing number of public guarantees, explicit or implicit, which does not help with the readability. London School of Economics October 22nd, 2010 8 Financing the public debt in times of crisis 2. A new governance of public finances appears to be necessary c) Too often budget previsions are based on optimistic economic previsions, this asks for constant readjustments not to say recurring revisions Deficit warnings never are well appreciated by rating agencies and markets. The long term planning is most often normative and leaves little room to unfavorable evolutions of the economic situation And yet, financial markets need plausible projections that can be followed continuously throughout the years A critical review on a fixed period basis, for example quarterly, using realistic terms is crucial for the plausibility of the reasoning. London School of Economics October 22nd, 2010 9 Financing the public debt in times of crisis 2. A new governance of public finances appears to be necessary d) Working at the European level is essential in order to bring on a balanced judgment on the evolution of public finances and ensure an effective solidarity The presentation of the documentation in terms of public finances of the different States should be standardized to enable comparisons of revenues, expenses, deficits and covering of the latter based on reliable information The idea is not simply to coordinate the budgetary policies and appeals to markets for the financing of the deficit but to aim for a real convergence of such policies The definition of the objectives that have to be reached needs to be more strict and sanctions must be executed should a State fail to reach such objectives London School of Economics October 22nd, 2010 10 Financing the public debt in times of crisis Conclusion The idea is not to debate on or criticize the role played by the financial markets in the financing of de the deficits and of the public debt. It is a fact, and nobody, bank or financial intermediary, is able to take the place of the markets. Because of the specificity of the public sector, the presentation, the follow-up, the standards of financing and public offerings, have all been developed in a very different way compared with what normally occurs in the private sector. To achieve a greater readability, transparency and credibility, it is time to work on the convergence of the methods and accounts used in the public sector and in the private one. London School of Economics October 22nd, 2010 11 Financing the public debt in times of crisis Schedule : a few figures illustrating the evolution of public finances Public Debt / GDP 2006 2007 2008 2009 Germany 67.6 65.0 66.0 73.2 Greece 97.8 95.7 99.2 115.1 France 63.7 63.8 67.5 77.6 Italy 106.5 103.5 106.1 115.8 GB 43.5 44.7 52.0 68.1 Source Eurostat London School of Economics October 22nd, 2010 12 Financing the public debt in times of crisis Schedule : a few figures illustrating the evolution of public finances Government surplus 2006 2007 2008 2009 Germany - 1.6 0.2 0.0 - 3.3 Greece - 3.6 - 5.1 - 7.7 - 13.6 France - 2.3 - 2.7 - 3.3 - 7.5 Italy - 3.3 - 1.5 - 2.7 - 5.3 GB - 2.7 - 2.8 - 4.9 - 11.5 Source Eurostat London School of Economics October 22nd, 2010 13 Financing the public debt in times of crisis Schedule : a few figures illustrating the evolution of public finances Gross debt (in billion Euros) 2007 2008 1 571 - - 1 762 Greece 205 - - 273 France 1 150 - - 1 489 Italy 1 582 - - 1 760 GB 861 - - 1 067 Germany 2006 2009 Source Eurostat London School of Economics October 22nd, 2010 14 Financing the public debt in times of crisis Schedule : a few figures illustrating the evolution of public finances Planned evolution of the public deficit (% GDP) Germany 2009 - 3.1 2010 - 4.5 2011 - 2012 2013 - 1.5 -3 (in 2014) France - 7.5 -8 -6 - 4.6 Italy - 5.3 -5 - 3.9 - 2.7 Greece - 13.6 -8 - 7.6 - 6.5 -3 - -3 (in 2014) Source : monthly newsletter of the ECB 09 - 2010 London School of Economics October 22nd, 2010 15 Financing the public debt in times of crisis Schedule : a few figures illustrating the evolution of public finances Planned evolution of the public debt (% GDP) France 2009 78.1 2010 82.9 2011 86.2 Source : economic and financial report – octobre 2010 London School of Economics October 22nd, 2010 16