23 May 2013

Bloomberg: European leaders saying no to austerity

Several months of calm in financial markets allowed EU leaders to deal with energy policy and a clampdown on tax evasion. The next steps in handling the financial crisis were put off to June when jobs, growth and the slowing push for a centrally-regulated banking system will top the agenda.

“It’s not a matter of money”, Merkel said. “It’s a matter of looking at how to spend this money most productively.” The 17-nation euro area’s non-stop contraction since the third quarter of 2011 has left the European Central Bank to try to mitigate the damage by cutting interest rates and exploring unconventional ways of channeling money to needy companies, especially in the south.

The tax-and-spending mix will be in focus on May 29, when the Brussels-based Commission recommends whether countries including France, Italy, Spain, Slovenia and even the traditionally low-deficit Netherlands deserve extra time to reduce their budget shortfalls.

Spain last year obtained a one-year extension. Prime Minister Mariano Rajoy acted as if another concession is a done deal, counting on a “fair and balanced” decision to grant Spain until 2016 to bring the deficit below the EU limit of 3 per cent of gross domestic product. The shortfall was 10.6 per cent last year.

Hollande, a leader of the anti-austerity faction, passed up the opportunity to make a growth-boosting plea at the summit. Instead, he stuck to the tax evasion theme, saying that budget constraints make it “better to ask those who don’t pay taxes to pay than to ask those who are already paying".  With Merkel running for a third term in September, German tolerance of looser fiscal policy is coloured by campaign tactics. Norbert Barthle, budget expert for Merkel’s party in parliament, warned against a reversal of the deficit reduction pursued since the crisis erupted in late 2009.

Even as Italy’s new government tilted away from austerity, Italian bonds have notched gains. The market now charges Italy 247 basis points more than Germany to borrow for 10 years, compared to 518 basis points in July 2012.  Two reasons stand out: last July 26, ECB President Mario Draghi unveiled what became the bank’s “unlimited” bond-buying offer, defusing the risk of a euro break up. And as the euro area’s longest-ever recession deepened, investors decided that too much belt-tightening was self-defeating. In Italy, the backlash carried Enrico Letta into power. Making his summit debut yesterday, Letta aims to cut property, consumption and payroll taxes, saying Italy is entitled to do so because last year’s savings drove the deficit below the EU ceiling.

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