Mar8, 2011, 10:13 PM
By Luke Baker
BRUSSELS (Reuters) - Euro zone leaders will take the next cautious steps in their year-long effort to quell the region's debt crisis at a summit on Friday, but the meeting is unlikely to produce a breakthrough.
The top item on the agenda for the 17 heads of state and government is to agree a "competitiveness pact", a deal Germany and France are pushing the rest of the euro zone to adopt to show their commitment to overhauling their economies.
The pact has been watered down since it was put forward by German Chancellor Angela Merkel and France's Nicolas Sarkozy last month, and now looks likely to win approval from the rest of the euro zone leaders, many of whom were alarmed by the initial proposals.
The more stringent elements, such as a commitment to abandon inflation-linked wage increases, are likely to be dropped, but there should be agreement on measures to limit public deficits, gradually increase retirement ages to reflect demographics, and work towards a common corporate tax base.
Any agreement is likely be hailed by EU leaders -- particularly Germany and France -- as a major step forward in the battle to stem the debt crisis, which has already led to bailouts for Greece and Ireland and still threatens Portugal.
But analysts regard competitiveness as a sideline issue that barely nudges the euro zone closer to tackling the fundamental problems underpinning the crisis -- bad banking debts and heavily-indebted sovereign nations with poor growth prospects.
"The competitiveness pact as it stands is largely meaningless, it's beside the point right now," said Simon Tilford, chief economist of the Centre for European Reform, a London-based think tank.
"The immediate issue is debt restructuring and bank recapitalisation and they're not dealing with that."
Friday's summit is only likely to lay the ground for a meeting of all 27 EU leaders in Brussels on March 24-25, when they hope to agree on a "comprehensive package" of measures they hope will draw a line under the crisis.
PORTUGAL BACK UNDER PRESSURE
Measures under discussion as part of the comprehensive package include reforms to the European Financial Stability Facility (EFSF), the 440 billion euro fund set up last May and used to bail out Ireland, and the creation of the European Stability Mechanism, a permanent fund that will replace the EFSF from mid-2013, and more banking stress tests.
Among issues to be resolved is whether the effective capacity of the EFSF will be increased to its full 440 billion euros. Because of guarantees needed for the fund to retain its triple-A credit rating, its effective capacity is currently 250 billion euros.
If Germany gets the rest of the euro zone to sign up to the competitiveness pact on Friday, there is an expectation that that will make Berlin more disposed to agree to a strengthening of the EFSF, which almost all other euro zone members want.
But Merkel's political allies at home are adamantly opposed to bolstering the EFSF, which would require more taxpayer-backed guarantees, and neither do they want the fund to be used to buy distressed euro zone debt, as many other countries favour.
Merkel's coalition lost an important regional election in Hamburg last week and is expected to lose another in Baden-Wuerttemberg on March 27, piling pressure on the chancellor to stick closely to what voters want, which is no more German taxpayer funds being used for EU bailouts.
A month ago, an enlargement of the effective lending capacity of the EFSF looked likely, as did the possibility of the fund being used to buy distressed euro zone bonds on the secondary market, or to lend money to countries such as Greece and Ireland to buy back bonds. All now look questionable.
"The wiggle room, the political room for manoeuvre on the part of the Germans, is worryingly limited," said Tilford.
"They are going to have to deliver something (on March 24-25) because the market reaction otherwise could be pretty adverse, but I fear that very little is going to be delivered."
European leaders, particularly Herman Van Rompuy, the president of the European Council, have cast the end-March summit as a defining moment, when the euro zone finally gets on top of a crisis that has wrought turmoil for more than a year.
But because of German domestic politics, persistent disagreement among member states over the best course of action, and external factors such as the likelihood that the European Central Bank will raise euro zone interest rates next month, the crisis may be about to enter another, more uncertain phase.
For months Portugal has said that it does not need EU/IMF assistance and can continue to fund itself in the market. But if there is no breakthrough on March 24-25, the likelihood of Portugal needing a bailout will increase. Already the majority of EU states believe this will happen in April.
That points to a renewed round of pressure on the debt of peripheral or highly-indebted euro zone states, with not only Portugal, but Spain, Belgium and Italy in the picture.
"Portugal will be forced into a bailout and will subsequently, like Ireland and Greece, be forced to restructure its debt," said Tilford. "Portugal looks very vulnerable."
The top item on the agenda for the 17 heads of state and government is to agree a "competitiveness pact", a deal Germany and France are pushing the rest of the euro zone to adopt to show their commitment to overhauling their economies.
The pact has been watered down since it was put forward by German Chancellor Angela Merkel and France's Nicolas Sarkozy last month, and now looks likely to win approval from the rest of the euro zone leaders, many of whom were alarmed by the initial proposals.
The more stringent elements, such as a commitment to abandon inflation-linked wage increases, are likely to be dropped, but there should be agreement on measures to limit public deficits, gradually increase retirement ages to reflect demographics, and work towards a common corporate tax base.
Any agreement is likely be hailed by EU leaders -- particularly Germany and France -- as a major step forward in the battle to stem the debt crisis, which has already led to bailouts for Greece and Ireland and still threatens Portugal.
But analysts regard competitiveness as a sideline issue that barely nudges the euro zone closer to tackling the fundamental problems underpinning the crisis -- bad banking debts and heavily-indebted sovereign nations with poor growth prospects.
"The competitiveness pact as it stands is largely meaningless, it's beside the point right now," said Simon Tilford, chief economist of the Centre for European Reform, a London-based think tank.
"The immediate issue is debt restructuring and bank recapitalisation and they're not dealing with that."
Friday's summit is only likely to lay the ground for a meeting of all 27 EU leaders in Brussels on March 24-25, when they hope to agree on a "comprehensive package" of measures they hope will draw a line under the crisis.
PORTUGAL BACK UNDER PRESSURE
Measures under discussion as part of the comprehensive package include reforms to the European Financial Stability Facility (EFSF), the 440 billion euro fund set up last May and used to bail out Ireland, and the creation of the European Stability Mechanism, a permanent fund that will replace the EFSF from mid-2013, and more banking stress tests.
Among issues to be resolved is whether the effective capacity of the EFSF will be increased to its full 440 billion euros. Because of guarantees needed for the fund to retain its triple-A credit rating, its effective capacity is currently 250 billion euros.
If Germany gets the rest of the euro zone to sign up to the competitiveness pact on Friday, there is an expectation that that will make Berlin more disposed to agree to a strengthening of the EFSF, which almost all other euro zone members want.
But Merkel's political allies at home are adamantly opposed to bolstering the EFSF, which would require more taxpayer-backed guarantees, and neither do they want the fund to be used to buy distressed euro zone debt, as many other countries favour.
Merkel's coalition lost an important regional election in Hamburg last week and is expected to lose another in Baden-Wuerttemberg on March 27, piling pressure on the chancellor to stick closely to what voters want, which is no more German taxpayer funds being used for EU bailouts.
A month ago, an enlargement of the effective lending capacity of the EFSF looked likely, as did the possibility of the fund being used to buy distressed euro zone bonds on the secondary market, or to lend money to countries such as Greece and Ireland to buy back bonds. All now look questionable.
"The wiggle room, the political room for manoeuvre on the part of the Germans, is worryingly limited," said Tilford.
"They are going to have to deliver something (on March 24-25) because the market reaction otherwise could be pretty adverse, but I fear that very little is going to be delivered."
European leaders, particularly Herman Van Rompuy, the president of the European Council, have cast the end-March summit as a defining moment, when the euro zone finally gets on top of a crisis that has wrought turmoil for more than a year.
But because of German domestic politics, persistent disagreement among member states over the best course of action, and external factors such as the likelihood that the European Central Bank will raise euro zone interest rates next month, the crisis may be about to enter another, more uncertain phase.
For months Portugal has said that it does not need EU/IMF assistance and can continue to fund itself in the market. But if there is no breakthrough on March 24-25, the likelihood of Portugal needing a bailout will increase. Already the majority of EU states believe this will happen in April.
That points to a renewed round of pressure on the debt of peripheral or highly-indebted euro zone states, with not only Portugal, but Spain, Belgium and Italy in the picture.
"Portugal will be forced into a bailout and will subsequently, like Ireland and Greece, be forced to restructure its debt," said Tilford. "Portugal looks very vulnerable."
(Editing by Stephen Nisbet,sourced:Reuters)
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