Download Current state of the sovereign debt crisis g Seppo Honkapohja

Current state of the sovereign
g debt crisis
University of Saint Andrews, February 2012
Seppo Honkapohja
Suomen Pankki
Views expressed are my own and do not necessarily
represent views of the Bank of Finland
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
I. Introduction
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
General government deficit
10
Spain
Ireland
Italy
Greece
Portugal
Germany
France
Finland
% of GDP
5
0
-5
-10
-15
-20
-25
30
-30
-35
1999
2004
Sources: Eurostat ja European Commission.
Commission
2009
24297@Alijäämät(en)
16.2.2012
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
3
General government debt
250
Spain
Ireland
Italy
Greece
Portugal
Germany
France
Finland
% of GDP
200
150
100
50
0
1999
2004
2009
Sources: Eurostat and European Commission
Commission.
24297@Velat(en)
16.2.2012
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
4
General government debt
United States
250
Japan
United Kingdom
% of GDP
200
150
100
50
0
1999
2004
S
Source:
European
E
Commission.
C
i i
2009
24204@Chart1 (en)
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
General government deficit
United States
6
Japan
United Kingdom
% of GDP
4
2
0
-2
2
-4
-6
-8
-10
-12
12
-14
1999
2004
S
Source:
E
European C
Commission.
i i
2009
24204@Chart2 (en)
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Euro area sovereign CDS prices
45
Percentage points
Greece
40
Portugal
35
30
Irland
25
Italy
20
15
Spain
10
Germany
5
0
Jan - 10
Jul - 10
Jan - 11
Jul - 11
Jan - 12
Finland
Source: Bloomberg.
g 5-year
y
CDS p
prices.
Quotations for Greece are no longer regularly available.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
7
Euro area bank CDS prices
28
%
Alpha
p
24
Banco Comercial
Bank of Ireland
20
Unicredit
16
Banco Santander
Raiffeisen
12
RBS
8
Rahoitussektori
(Eurooppa)
Deutsche Bank
4
0
Jan - 10
Nordea
Jul - 10
Jan - 11
Jul - 11
Jan - 12
Source: Bloomberg.
5-year CDS prices.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
8
Sovereign yield spreads vis-à-vis Germany (10 y)
35
Percentage points
Greece
30
Portugal
25
Ireland
20
15
Italy
10
Spain
5
Finland
0
01/10
04/10
07/10
10/10
01/11
04/11
07/11
10/11
01/12
Source: Bloomberg
Bloomberg.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
9
GDP, GIIPS
Euro area
115
Spain
Ireland
Italy
Greece
2008
2009
2010
Portugal
2005 = 100
110
105
100
95
90
2005
2006
Source: Eurostat
Eurostat.
2007
2011
23586@Chart40(en)
16.2.2012
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
10
Inflation,, GIIPS
7
Spain
Ireland
Greece
Portugal
% change from previous year
Italy
Euro area
6
5
4
3
2
1
0
-1
-2
3
-3
-4
2005
2007
2009
2011
S
Source:
Eurostat.
E
t t
23586@Chart1(en)
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Current account,, GIIPS
Spain
Greece
5
Ireland
Portugal
Italy
Euro area
% of GDP
0
-5
5
-10
-15
-20
1999
2004
2009
S
Source:
European
E
Commission
C
i i fforecast,
t Autumn
A t
2011.
2011
23586@Chart4(en)
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
II. Design
g faults?
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Current account and public deficits in Greece,
Ireland, Portugal and Spain in 2003-2009
Spain
Ireland
Public deficit
P
Portugal
Greece
Eurostat
C
Current
t accountt
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
14
Assessments on Greece 2006-2007
 IMF (Article IV report,
report Dec 2006):
– ” Significant fiscal consolidation was put in place in 2005–06, but
further deficit cuts are needed.”
– “Vulnerabilities
Vulnerabilities have developed in the form of very high credit
growth, persistent inflationary pressures, eroding competitiveness,
and an unsustainably large current account deficit.”
 OECD (Country report,
report May 2007):
– “There has been substantial [fiscal] consolidation since 2004.“
– “Losses in competitiveness may ultimately undermine growth
p
performance.”
– “The clearest sign of macroeconomic tension is an increase in the
current account deficit.”
 Broad p
picture in 2006-2007:
– Fiscal situation seen to be on the mend.
– External deficit seen as a vulnerability.
– But no alarm bells, no perceived need for drastic action.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Assessments on Ireland 2006-2007
 IMF (Article IV report,
report June 2006):
– ”Economic policies have been in line with Fund policy advice.”
– ”Financial system continues to perform well, but rapid credit growth is a
vulnerability.”
y
– “concentration of lending in property-related sectors… banks’ reliance on
wholesale funding…”
– “Regulatory and supervisory framework has been strengthened in line with
the recommendations of the 2000 FSAP
FSAP.”
 OECD (Economic survey, March 2006)
– “The fiscal position is healthy.”
– “House
House prices may have overshot fundamentals to some extent,
extent although
this does not imply that they will fall significantly.”
 Broad picture in 2006:
– Growth performance based on genuine productivity miracle, strong public
finances.
– Well-supervised financial sector, but property sector risks recognized.
– Again, no alarms sounding!
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Current account – the missing link
 Before the crisis,
crisis
– Current accounts within a monetary union were seen as largely
unimportant.
– Balance-of-payments
Balance of payments crises were seen as largely impossible:
• BOP crises traditionally involve run on a currency, forcing
interest rates up.
• But monetary union shares a common currency and interest
rate, so there is no risk of speculative attack.
 Now we know that:
– Sovereigns within a currency union are leveraged entities and can
be subject to a run,
• … and once a sovereign is targeted, the financial sector goes
down with it.
– As long as solvency is defined along national borders, the monetary
union alone does not shield from a BOP crisis.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
A regulatory failure?
 Stability and growth pact focuses only on public
finances.
– More generally,
generally national imbalances and competitiveness were
not included.
– The 2003 revision of the Stability and Growth Pact clearly
unfortunate.
• The new Pact was not necessarily much worse than the old,
but revision had wrong motivations.
motivations
– Signalled lack of political will for macroeconomic
coordination.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
 The ”No
No bail out
out” –clause
clause had no real bite.
bite
– No enforcement mechanism.
 Integration of euro countries had not not progressed
sufficiently far.
– In particular, regulation and supervision of financial markets had
remained entirely national.
– Financial markets did not impose sufficient discipline on member
countries.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
III. EU and euro area reforms
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
TREATY ON STABILITY, COORDINATION AND
GOVERNANCE
IN THE ECONOMIC AND MONETARY UNION
 To foster budgetary discipline through a fiscal compact
 To strengthen the coordination of economic policies
 To improve the governance of the euro area (“Six Pact”)
– Fiscal surveillance and enforcement
– Macroeconomic imbalances and enforcement
– More automatic sanctions
 The treaty shall enter into force on 1 January 2013 if
ratified by 12 euro area countries.
 The aim is to incorporate this treaty into the legal
framework of the European Union within five years.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Fiscal compact
 The budgetary position of the general government
should be balanced or in surplus.
 Medium-term
M di
t
objective:
bj ti
structural
t t l budget
b d t deficit
d fi it nott to
t
exceed 0.5 % of GDP.
 Structural deficit of at most 1 % of GDP allowed if the
ratio of government debt is significantly below 60 % and
risks
s s in terms
e so
of long-term
o g e sus
sustainability
a ab y a
are
e low.
o
 Contracting parties may temporarily deviate from their
medium-term objective
j
or the adjustment
j
p
path towards it
only in exceptional circumstances as defined in Stability
and Growth Pact.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Fiscal compact (II)
 The rules should be incorporated in the national law of
the contracting parties at the latest one year after the
entry into force of the treaty
treaty.
 The provisions in the national law should be binding,
permanent and preferably constitutional or otherwise
guaranteed to be respected throughout the national
budgetary processes.
– Compliance ultimately judged by European Court of Justice.
 A correction mechanism to be triggered automatically in
the event of significant deviations as specified in the
revised Stability and Growth Pact.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Excessive Deficit Procedure (EDP) and
European Stability Mechanism (ESM)
 European Commission may initiate an excessive deficit
procedure which includes deficit targets over several
years.
years
 Automatic sanctions on euro area countries with
excessively high budget deficits; can be avoided only
with a reversed qualified majority.
 The
e pe
permanent
a e European
u opea S
Stability
ab y Mechanism
ec a s ((ESM)
S ) to
o
replace the temporary EFSF should be operational in
mid-2012. The lending capacity of ESM will be 500
billion euros.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
 The objective of the reforms is to move toward a
”Maastrict plus” type system, not a complete fiscal union.
– Each country has responsibility of its economy.
– The aim is to strictly apply the commonly accepted rules.
 Eurobonds?
– Several proposals, perhaps best known is the idea of blue bonds
and red bonds.
– Would move Europe (excluding UK?) strongly toward federalist
direction
• It seems that
th t there
th
i nott very much
is
h support,
t exceptt in
i th
the
problem countries.
– Would p
probably
y require
q
changing
g g a change
g in the EU Treaty.
y
• Not a tool to resolve the current crisis?
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
IV. Policies in the crisis countries
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
 Necessary to achieve a turnaround in the public debt to
GDP ratio and then p
proceed with reduction of
indebtedness.
– This will take 10-20 years.
 Consolidation of public finances
– To convince the markets and the creditors
– Negative
N
ti impact
i
t on economic
i growth
th in
i th
the short
h t run.
 Structural policies
– To improve economic growth in the medium to long run
– Improving the legitimacy of government and administration
• Achieving
g the p
positive effects will take time.
15.11.2011
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
27
Greece vs.
vs Italy
Greece
Italy
74,5
60,5
18,2
21,1
Investments
16 6
16,6
19 7
19,7
Export
21,5
26,7
Import
30,4
28,6
Current Account (92 – 10)
‐8,3
‐0,1
% of GDP, 2010
Private consumption
expenditure
Government consumption
expenditure
Source: European Commission.
15.11.2011
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
28
Challenges for Greece
 2012 will be the 5th year with falling GDP.
 Debt-GDP
G
ratio will be nearly 200 % at the end off the year
unless something is done.
 Major changes in the economy:
– Private consumption must go down a long time..
– Massive need to move productive resources from public and closed
private sector to export production.
– Where are the new industries for exports?
 Major program for public sector consolidation and reform.
reform
------------ A second aid package under negotiation.
negotiation
 Voluntary restructuring of public debts held by the private
sector under negotation.
15.11.2011
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
29
Challenges for Italy
 There are some strong private sectors and private sector
financing is working so far. But:
 Liquidity
Li idit crisis
i i because
b
off high
hi h public
bli debt.
d bt
 Too big to fail?
– Country’s
Co ntr ’s own
o n actions decisive.
decisi e
– The new government has had a good start?
 Balancing of public finances is necessary (and should be
achievable),
 But weak growth performance necessitates structural
reforms to improve long-term sustainability.
15.11.2011
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
30
Challenges for Portugal
 External adjustment gathered pace lately and structural
adjustment program started off fairly well.
 But:
B t
– Weak growth and structural problems deep rooted.
– Debt flows have helped to avoid adjustment in domestic
demand, debt servicing burden has become problematic.
– Needs for relative price changes to improve competitiveness, but
probably
b bl smaller
ll than
h eg Greece.
G
– Refinancing of public and private debt remains extremely
challenging.
g g
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Reprioritisation of resources towards tradable
sector has seemingly started
Portugal
Greece
Poland
Export of goods and services, as % of GDP
50
40
30
20
10
2000
2002
2004
2006
2008
Source: national authorities
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
2010
External adjustment speeding up, but large
debt burden keeps debt servicing still high
Current account (6 m average)
Net trade (goods and services, 6m average)
mio
EUR
0
-500
-1000
-1500
-2000
2000
2000
2002
2004
2006
2008
Lähde: national statistics
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
2010
V. Examples
p
of succesful ((?)) adjustment
j
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
GDP: Estonia
Estonia, Latvia
Latvia, Ireland and Iceland
E t i
Estonia
200
L t i
Latvia
I l d
Ireland
I l d
Iceland
Index, 2000 Q1 = 100
180
160
140
120
100
80
2000
2002
2004
2006
2008
Sorces: Eurostat, National authorities.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
2010
Government debt: Estonia, Latvia, Ireland and
Iceland
Ireland
120
Estonia
Latvia
Iceland
% of GDP
100
80
60
40
20
0
2000
2002
2004
2006
2008
2010
Sorces: Eurostat (Q3 for 2011), Iceland (for 2000-2004) national
authorities and for 2011 IMF forecast.
forecast
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
Thank you!
y
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND