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Thursday, July 28, 2011

Euro: Hanging on the Edge?

It all started with Greece. The drama of sovereign debt then shifted to Ireland; then Portugal; again Greece; and now it is the turn of Italy. And every time, the audience reacted in the same way: denial and dithering, though the developments are pretty grave. Indeed, Jens Weidmann, the Bundesbank president and European Central Bank governing council member, warned about the gravity of the unfolding woes as early as on May 20: “Events in Greece have brought the euro area to crossroads: the future character of European monetary union will be determined by the way in which this situation is handled.”

The evidences for inaction from the member countries of Euro that matter in rescuing these countries are galore. Take for instance, the current plight of Italy, the Eurozone’s third biggest economy. The epicenter of its crisis is ECB. It all started with the banning of the European Central Bank (ECB) from directly buying bonds issued by the governments. With the result, Italy was forced to pay 100 basis points more than what it had paid just a month back for raising Euro 1.25 bn by way of a 5-year debt.

The significance of this trauma can be better understood when it is juxtaposed with what happened with the US: it raised a two-week debt of $5 bn paying zero per cent interest. And the macroeconomic fundamentals of these two countries do not differ much: both suffer from too much sovereign debt. According to IMF estimates, Italy’s government debt is all set to hover this year around 120% of its gross domestic product—the world’s third biggest sovereign debt market—while that of the US is likely to reach 99.5%. But encouragingly, the fiscal position of Italy, according to pundits, is improving, while that of the US is further deteriorating.

The logical question that emerges out of this scenario is: Why then this difference in the treatment of debt issued by these two countries by the global private investors?

The answer is simple: in the event of private investors not subscribing to the debt issued by the US, its Federal Reserve can step in to airdrop the dollar bills by printing them in its presses. Whereas, Italy does not enjoy this comfort, for it has no central bank of its own. And hence the wildfire!

Indeed, it is not for the first time that this has happened. This is precisely what set Greece on fire in April 2010, and continues to tease it even now. Same is the reason for the troubles brewing in Portugal, Ireland, and perhaps in Spain.

This, however, doesn’t mean that the blame for the current problems in these countries entirely rests on the ECB. To be fair to the ECB, we must admit that the roots of the current plight of these countries are in the fiscal policies adopted by them in the earlier years.

Given that, a way out of the current mess is in the very interest of European Union. And the responsibility to find the way out squarely rests on the ECB and the Chancellor of Germany. They can no longer afford to dilly-dally between contradictory pursuits: of not allowing Greece to default, nor allowing free flow of funds from richer European countries to the insolvent member countries of the Eurozone.

It is time Germany took a firm initiative to launch an ‘operation-repair’ forthwith: debt reduction for countries like Greece; recapitalization of European countries that are likely to suffer from such restructuring of debt; and ring-fencing the insolvent countries from the rest of the Eurozone, while at the same time the crisis-ridden countries learn to behave. Else, the future is written large: end of the Euro.

GRK Murty


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