Euro zone waiting game

October 15, 2012

Some interesting flesh to pick from the bones of the IMF gathering in Tokyo. Most notably, a clutch of high-up euro zone sources in Tokyo told us that Spain could ask for aid next month at the same time as the Greek bailout package and one for Cyprus are sorted out. All roads appear to be pointing to the Nov. 12 meeting of euro zone finance ministers. However, there are other voices saying that Spain could hold off until the new year, given the fall in its borrowing costs since ECB chief Mario Draghi declared he would do whatever it takes to save the euro.

Spain can cover a fairly heavy debt redemption hump at the end of this month but given its recession is deepening, and deficit targets are likely to be missed, the refinancing crunch could fall in January. Prime Minister Mariano Rajoy remains a difficult character to read but we know the French are pressing him to jump and Italy’s Mario Monti said on Friday that a Spanish request for bond-buying help would calm the markets.
For his part, Rajoy wants to know what sort of deal he will get. As we reported last week, and El Pais followed up on, he is asking how the ECB would intervene with a preference for it to commit to achieve and maintain a certain yield spread over German Bunds.

Nearly everybody, including, crucially, Angela Merkel, has come round to the view that Greece should stay in the euro zone for now. The possible exception has been German Finance Minister Wolfgang Schaeuble but late yesterday, in Singapore, he too seemed to fall into line saying that Greece will not default and that he wanted to shut down any talk of euro zone exit.
Greek PM Antonis Samaras put his foot on the accelerator over the weekend, predicting the broad outlines of a deal on a new austerity package in time for the EU summit at the end of this week, although he appeared to be talking about the troika of EU/IMF/ECB inspectors finishing their work on the ground, rather than a new deal being sealed in full.

That Athens is going to miss its debt-cutting targets is not in doubt given the lack of progress on numerous fronts and an ever-deepening recession. ECB policymaker Joerg Asmussen suggested it could launch voluntary buy-backs of its bonds with money lent by the ESM rescue fund. Because Greek bonds have dropped so far in value, one euro could buy back 1.5 euros of debt. But his ECB colleague, Benoit Coure, ruled out the ECB taking a writedown on the Greek bonds it holds and euro zone governments are equally chary of doing the same. Another euro zone official told us Greece could use proceeds from its privatization drive, which is finally showing signs of life, to retire debt. So plenty of ideas are circulating.

The other element from the IMF that potentially changed the game was its admission that it had miscalculated the effect of fiscal multipliers – that is the effect public spending has on growth through second round effects and the reverse effect that spending cuts have. In other words, it now thinks austerity has delivered a bigger hit to economies than it did previously. That was coupled with Christine Lagarde’s plea for some countries not to frontload debt-cutting. Could this change the debate? As former U.S. treasury secretary Lawrence Summers says in his column for us today: “The IMF’s recognition of the need to sustain demand and avoid lurches to austerity can be very important for the medium term if and only if it is sustained through the next round of economic fluctuations.”

On that theme, Portugal will present its 2013 budget which will include its harshest measures yet  — sharp income tax rises which have already mass public protest and marked the end of the broad consensus on what needed to be done that had served Lisbon well up until last month. Economists say a Greek-style downward spiral is now very much a possibility.

Also on that front, Lithuanians kicked out their government at elections on Sunday – a rejection of its austerity policies which turned the country around after a crash four years ago but lost voters in the process. Interesting to watch market reaction today. It’s no longer clear that investors are hankering for a slavish debt-cutting to the exclusion of everything else.

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