The eurozone crisis is anything but sterilized
Mario Draghi hasn’t rescued the euro yet
German eurosceptics claim that the ECB’s Outright Monetary Transactions (OMT) programme is an abuse of power. The emergency asset purchasing measure, inactive since its inception in 2012, would force all eurozone members to share any losses involved in bailing out a struggling state. According to the plaintiffs in the case, this infringes on fiscal sovereignty.
The German Constitutional Court has deferred the judgment to the European Court of Justice (ECJ), though this has only delayed dealing with the problem rather than put it to bed. Nonetheless, the decision will please eurosceptics.
At present, the very existence of the OMT is acting as a safety net. Bond investors are suitably reassured and bond yields are at a sustainable level. Yet, an ECJ ruling has the potential to ruin the peace. If asked to contribute to the rescue fund, the Germans would have grounds to abstain, leaving struggling eurozone members unable to service their debt.
Were a member state to require access to the OMT funds, it is unlikely that proceedings would ever reach the stage where the German constitution is called into question. Troubled sovereigns are first required to apply for a credit line via the European Stability Mechanism. This requires clearance from all member states, which of course includes Germany. This roadblock should prove enough of a deterrent to prevent countries from accessing OMT in the first place.
The pending decision could irk bond markets, but there are more troubles on the horizon for Mario Draghi. The ECB is about to enter phase two of its investigation into the eurozone’s financial system. The asset quality review will highlight any weaknesses in the capital held by banks. In Italy, non-performing loans have risen 8% since 2007. In his January 5th column, Wolfgang Munchau noted that the government was unlikely to implement the tax measures necessary to reduce unit labour costs. The difference in wage rates between member states is one of the fundamental problems currently plaguing the eurozone.
The Italian government faces debt-servicing charges of 70 per cent of GDP over the next 20 years. With tax receipts projected to remain flat throughout the period, this is a repayment schedule that has not been witnessed before in the eurozone.
Italy is stuck between a rock and a hard place. Incoming prime minister Matteo Renzi has announced a four-month reform programme, expected to include boosts to government spending. And yet, the country is already on the margins of the 3% primary deficit ceiling imposed by Brussels. Though inflation is reaching dangerously low levels, the ECB has made clear that it will not give highly indebted member states the means to inflate their problems away.
If the Eurozone crisis has taught us anything, it’s that confidence is a fragile thing. Given that growth in the currency union is stagnant and the central bank has made clear that it is unwilling to pull any more levers, the last thing that the periphery needs is more uncertainty. That Germany has the upper hand in OMT negotiations will plant a seed of doubt in the minds of investors. With a European parliamentary election in May and rigorous bank stress tests due before November, Draghi definitely isn’t out the woods yet.