ANALYSIS-G20 to endorse EU crisis strategy, no new action

By Reuters Staff
May 28, 2010

By Brian Love

PARIS, May 28 (Reuters) – Finance chiefs of the world’s leading economies, meeting next week, are likely to deliver a strong endorsement of Europe’s efforts to resolve its debt crisis but announce no fresh policies to help it do so.

After several months in which Washington, Beijing and other governments pressed Europe to act more decisively in tackling the crisis, global policy makers now appear to feel a strategy with a reasonable chance of success is in place, and that it should be given time to work.

So finance ministers and central bank chiefs of the Group of Twenty nations, meeting in South Korea on June 4 and 5, are likely to praise Europe and present a united front on the crisis, hoping to reassure financial markets.

U.S. Treasury Secretary Timothy Geithner said in London on Wednesday that European governments had put together a “very strong programme of reforms on the fiscal side and a very strong commitment on the financial side”, adding that implementing the plans was now key.

An official of a G20 government involved in preparing for the meeting said he did not think Europe or the G20 would announce any further policies for now, since steps to handle the crisis had just been revealed and were being carried out.

The G20 meeting is likely to emphasise that Europe will implement its plan and that markets are expected to stabilise, said the official, who declined to be named.

TWO-PRONGED STRATEGY

Early this month G20 governments were clearly worried that some European countries might not be able to summon the political will to confront their public debt problems.

U.S. President Barack Obama spoke personally to Spanish Prime Minister Jose Luis Rodriguez Zapatero to urge him to implement budget reforms. G20 officials held conference calls to discuss European policy.

Since then, Europe has come up with a two-pronged strategy. One prong is a string of national austerity schemes designed to bring state budget deficits and public debt down to safe ratios of gross domestic product in the next few years.

The most heavily indebted states on the periphery of the euro zone, Greece, Portugal, Spain and Italy, have announced austerity drives this month. Even France, a stronger country, has acted, announcing an intention to enshrine deficit-cutting in its constitution.

The other prong is emergency liquidity support from rich nations to give time for austerity steps to work; this ensures countries retain access to financing even if they lose the ability to fund themselves in the debt market, as Greece has.

In addition to a 110 billion euro bailout of Greece, European nations are creating a financial safety net for indebted countries that along with support from the International Monetary Fund could total 750 billion euros — three-quarters of the total public debt of Greece, Portugal, Ireland and Spain.

Markets are only partially reassured by this strategy, as shown by continued strains in the euro zone’s interbank money market. There are doubts over some governments’ will to stick to austerity over the long term, and over rich states’ willingness to fund indebted countries for as long as necessary.

A minority of analysts thinks austerity steps in Greece and perhaps other states cannot work since the countries are fundamentally insolvent, making eventual debt restructuring inevitable, Reuters polls show. Germany’s push for an orderly insolvency process for indebted euro zone states aims to handle this contingency.

But senior European officials have said publicly that markets are too fragile for a country to risk restructuring its debt at present without triggering a wider financial crisis.

Also, the G20 worries that Europe’s austerity policies could slow the recovery of the global economy from recession; G20 officials said this would be a major topic of discussion at next week’s meeting. Any debt restructuring in Europe could deliver a fresh blow to growth by hurting commercial banks.

So for now, the G20 appears content to throw its weight behind Europe’s effort to insulate itself from the markets with emergency loans while trying to work through its debt.

A senior U.S. monetary official, St. Louis Federal Reserve President James Bullard, seemed to endorse this approach on a visit to Stockholm on Thursday, saying Europe had “bought time” for its governments.

“If there is some kind of restructuring out there in the future, it will be down the road, probably several years at this point,” Bullard said.

UNITY

Another official from a G20 government said the group was likely to deliver a message of unity and solidarity with Europe at next week’s meeting.

That by itself could help to reassure the markets, which were thrown into turmoil last week when Germany shattered an emerging global consensus on financial market regulation and unilaterally banned some forms of short-selling.

Convincing investors that the G20 was still moving towards agreement on financial regulation, and that it was at least trying to coordinate fiscal policies to protect economic growth, could reduce market instability.

“They can provide a strong signal to global markets that they mean it politically when they say they want to coordinate policy,” said Pier Carlo Padoan, chief economist at the Organisation for Economic Co-operation and Development.

“A collective effort and a collective political investment from the G20 would benefit everybody.”

In April 2009, a show of unity by G20 leaders at a summit in London marked the start of markets’ recovery from the global financial crisis and may have contributed to the return of confidence. Next week’s meeting, and a G20 leaders’ summit in Toronto in late June, could conceivably have a similar effect in the European debt crisis.

Analysts believe G20 governments and central banks have a number of policy options in reserve if the crisis worsens. One is for the U.S. Federal Reserve to cut the rate it charges the European Central Bank for the dollar swaps which it revived this month to ease tensions in Europe’s money market.

Use of the swaps by commercial banks has been modest, which some traders have blamed on their price. But Bullard said this week that he believed the swaps were little used because financial strains were less serious than those in late 2008.

Another option, if weakness of the euro does too much damage to confidence in euro zone assets, would be concerted intervention by major G20 central banks to support the currency.

But so far, ECB officials have not even started issuing verbal warnings about excessive currency weakness, and they are aware that the euro’s drop to four-year lows is helping sustain economic growth in the zone.

If financial conditions deteriorate further, the ECB has options including another cut in record-low official interest rates and a massive expansion of its purchases of government bonds. But these are radical steps that could be seen as signs of panic by markets, so the central bank is expected to hold them in reserve for the foreseeable future. [ID:nLDE64Q0JL] (Editing by Andrew Torchia) ((brian.love@reuters.com; +33 1 49495339; Reuters Messaging brian.love@reuters.com@reuters.net))

Friday, 28 May 2010 10:20:59RTRS [nLDE64K1YB] {C}ENDS

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