Ending the political impasse over reforms to further reduce and share risk in the euro area is crucial. Scope Ratings is confident policy makers can find common ground. But will it be before a future crisis or triggered by one?
Political willingness to move closer towards a banking and capital markets union in Europe and developing a fiscal capacity for the euro area is limited for now.
Germany and France have made it clear that EU and euro area priorities are now focused on the migrant problem, defence and security, with euro area financial reform present but rather low on the list.
Progress on deepening euro area integration is proving difficult partly because member states have emerged from the last crisis in differing degrees of financial and economic health, from levels of government debt, unemployment and non-performing loans to investment. National electoral cycles also interfere with negotiations while favourable economic developments may also seed complacency.
“Even so, the broad contours of further euro area reform centred on reducing and sharing risk among member states are clear,” says Scope analyst Alvise Lennkh.
Northern European countries want crisis prevention, insisting on more “risk reduction” before any “risk sharing” can take place. This would include policies or instruments for greater fiscal oversight and possibly some framework for sovereign debt restructuring.
Southern European countries contest such an approach, given elevated government debt, on average, and higher refinancing needs were such a restructuring framework in force. They note the institutional reforms and steady declines in NPLs which make the euro area more resilient than it was a decade ago.
Better, in their view, to undertake more “risk sharing,” by completing the Banking Union, specifically by establishing the ESM as a credible common backstop for the Single Resolution Fund and introducing a European Deposit Insurance Scheme. Additional policies and instruments might include some form of euro area budget or “rainy day fund” and further enhancing the ESM.
The current impasse could be overcome through a “grand bargain” whereby Banking Union is completed, with new shock-absorbing mechanisms introduced in exchange for more fiscal surveillance and a framework for sovereign debt restructuring, says Lennkh.
When and how this might happen remains unclear. The political will may be lacking at the upcoming EU Councils. At the same time, Italy’s systemic political and economic importance, plus concerns about the fragility of the international multilateral system—in other words, the realisation that European member states need to rely on each other to address regional and global issues to safeguard their national interests on the global stage—could provide the necessary impetus for Europe’s governments to strike a deal.<