Italy and Eurozone leaders stances

by Véronique Queffélec on juin 17, 2012


June 14th , 2012

Key summary

Italy’s Unsustainable Path

A more prolonged and deep recession than expected.

An unsustainable fiscal path, ratings at risk.

Italy is likely to need external help at some point.

A set of measures aimed at reducing the stock of public debt likely to be welcome by the Eurozone.

Euro Area Leaders : a coalition against Germany ?

Germany, France, Italy and Spain to hold a mini-summit on the 22nd of June to prepare for the 28th-29th of June European Council.

Italy’s PM Monti said that he and French President Hollande were strongly in agreement on measures to tackle the euro area crisis.

Merkel for gradual move to political union.

Another hard blow for the French-German Alliance

Hollande’s government agrees with the German centre-left Social Democrats (SPD) over euro crisis.

Merkel criticized French economy.

The disagreement between the two big powers comes at a crucial time for the EU.

Key analysis

1/ Italy

A more prolonged and deep recession than expected

The Italian government’s expects an evolution of GDP of -1.2% in 2012 and +0.5% in 2013. however, some forecasters predict that Italy will experience a deeper recession with a contraction in GDP of around 2.5% and 2.0% respectively (as most views reflect the forecast of a further escalation of the sovereign debt crisis).

An unsustainable fiscal path

With current market yields, Italy’s fiscal position is probably on an unsustainable long-term path. Moreover, the situation could rapidly become critical, because the country is highly vulnerable if the sovereign debt crisis persists or intensifies. A significant further rise in yields risks triggering a vicious cycle.

If yields continue to rise, it might be logical to anticipate further downgrades of Italy’s sovereign ratings.

Italy is likely to need external help at some point

Even if some of Italy’s strengths might be acknowledged, it is likely that after getting support from the ECB twice already, in an environment of increasing funding costs, Italy will again require help from the ECB, the IMF and the EFSF/ESM at some point.

Disposal of state assets to come shortly according to Monti

PM Monti announced at a public event in Berlin yesterday that Italy would shortly be implementing a set of measures aimed at reducing the stock of public debt.

Monti said that the government was working on a privatization plan which would involve public assets held mainly at local levels (Region and Town Hall). He also said that they are taking under consideration property assets, as well as stakes in public companies. The disposal of those assets would be implemented through “special vehicles”.

He said that Italy also planned to cut expenditures by €5 billion this year and by €8 to €9 billion in 2013.

Monti’s announcement will probably be welcomed

Italy’s large stock of debt is a structural vulnerability. Therefore, lowering the stock of public debt through privatizations would probably be welcomed by the EU, while details still have to be released. The scale and scope of the privatization plans would be key, as would the roadmap for implementation.

The intention of cutting public expenditures is likely to be seen as a positive. The primary balance adjustment to be deployed through 2014 relies on higher revenues and lower spending. A rebalancing towards expenditure cuts could therefore be beneficial for the Italian economy, and particularly please Germany if it leads to lower labour taxation.

2/ Euro Area Leaders: a coalition against Germany?

Mini Summit on the 22nd of June

After a meeting with French President Hollande on Thursday, Italian PM Mario Monti confirmed that there would be a meeting of the leaders of Germany, France, Italy and Spain on the 22nd of June to prepare for the EU Summit on the 28th and 29th of June. Monti said that he and Hollande were strongly in agreement on measures to tackle the euro area crisis. François Hollande indicated in a press conference that he had sent his proposals to EU president Van Rompuy for the EU summit and that he believes that his suggestions will be part of a consensus to solving the euro area crisis.

France pushes for debt redemption fund and ESM banking license

His recommendations to stimulate growth in Europe include a mechanism to support banks and to protect States which are taking the appropriate policy action from attack by speculators. France’s preference is to give the ESM a banking license to improve financial stability and to launch a debt redemption fund to foster closer fiscal integration.

On Greece, Hollande is pushing for Europe to do its duty in terms of growth for Greece by rapidly deploying structural funds.

Spain will likely be cheering the proposal, given its previous declarations and current predicament. It is very doubtful that the ESM banking license proposal will be acceptable to Germany under the current circumstances.

3/ Another hard blow for the French-German Alliance

Angela Merkel criticized France’s economic performance

After Hollande and Monti’s declarations on how to tackle Europe’s deepening debt crisis ahead of determining elections in Greece, Merkel started to be vehement and invited France to reconsider its decisions on economy. Describing her own country as Europe’s “stabilising anchor and growth engine”, Merkel said that Europe should talk about the growing gap between the bloc’s two biggest economies and traditional allies.

The disagreement between the two big powers comes at a crucial time for the EU, which could find itself scrambling to avert a humiliating breakup as early as Sunday if a radical left party wins the vote in Greece.

Merkel said that only 10 years ago Germany dangled agreement with France on traditional measures of competitiveness, such as unit labour costs. According to her, Germany has now opened up a “growing” lead, saying this was an issue “that must be discussed in Europe, naturally.”

A union against Germany ?

Tensions have risen so much that French Prime Minister Jean-Marc Ayrault felt moved to deny that his country was trying to form a united front with Italy and Spain against Merkel and her drive for austerity in the Eurozone.

This put ahead the fear expressed after Hollande’s election that the Franco-German partnership may no longer thrive as it did under his predecessor, Nicolas Sarkozy, whom Merkel supported during the campaign, refusing to meet with the Socialist candidate.

Sarkozy’s conservative UMP, now in opposition, accused the ruling French Socialists of feeling “obliged to sabotage” the Paris-Berlin dialogue because it disagreed with Merkel. UMP criticised Ayrault for advising Merkel to “take things seriously and courageously” and French Industry Minister Arnaud Montebourg for saying Merkel’s “ideological blindness” was to blame for having “driven seven countries from the euro zone’s 17 into recession”.

Left parties coalition between France and Germany

This sudden rise of tension came after Hollande met with German centre-left opposition leaders this week and unveiled economic reforms, including a partial lowering of the pension age, that Berlin fears will only deepen France’s economic problems.

In addition to the pensions move, Hollande’s government has announced plans to increase the cost for companies of laying off workers. Among her critical analysis of French economy, Merkel pointed out the cost of labour and quite sarcastically invited the government of Hollande to make a comparison with the German system.

Merkel reiterated her view that issuing new debt to finance growth is not sustainable and she again ruled out mutualising debt or issuing joint euro bonds to tackle the crisis - a stance directly opposite to that taken by Hollande.

Hollande’s positions are shared by Germany’s centre-left Social Democrats (SPD) and Greens, who have been encouraged by the Socialist victory in France to reinforce their opposition to Merkel ahead of next year’s German federal elections.

SPD leader Sigmar Gabriel said after meeting Hollande and Ayrault (PM) in Paris on Wednesday there was “no crucial point” on which his party and the French government disagreed, including the need for a tax on financial transactions in Europe.

This meeting with the SPD’s three main leaders, was in itself a breach of official protocol as a new president would normally host a visit by the chancellor before there was any question of meeting the German opposition.

Tensions are expected to rise further after the legislative elections

Merkel has agreed, not always with strong enthusiasm, on four measures pushed by Hollande that were already on the agenda before his election: more capital for the European Investment Bank, reallocation of EU regional aid funds, project bonds to fund infrastructure and the transaction tax.

Hollande may be able to claim a victory if he gets Berlin to accept, at the 28th-29th of June EU summit, growth and job-creating measures to accompany the fiscal pact, which both the French and German parliaments still have to ratify.

François Hollande is the first Socialist president in 17 years, and is on track to win a clear parliamentary majority on Sunday, giving the left more power than it has never had in France.