On the surface, it seems strange: Spain is offered large loans at below-market interest rates, coupled with significant additional support by a regional central bank willing to buy the country’s government debt on the secondary market. Yet the government is reluctant to officially request this help.
However, Spain’s reluctance is rational, rather than a reflection of stubborn national pride or a misunderstanding on the part of the government. It is a well-founded hesitation to follow others in becoming a ward of the eurozone. Until the continent’s leaders fix these contradictions, the euro crisis will continue to pose a threat to Europe’s historic regional integration efforts.
In theory, there are four immediate upsides to the assistance offered to struggling members of the eurozone: it provides direct, cheap and sizeable financing to facilitate a country’s implementation of comprehensive reform measures; it unlocks financing from the International Monetary Fund, also at below-market rates; it indirectly lowers the cost of government debt by shifting liabilities from the private to the public balance sheets; and it reduces some of the obstacles facing credit-rationed companies and households.
Together, these advantages offer recipients the ability to minimise crisis-induced losses in output and jobs. Yet, judging from the first three years of European financial packages (for Greece, Ireland and Portugal), theory is yet to translate into practice.
Rather than crowd-in private funding, the packages have signalled the end of a recipient country’s access to private capital markets. With that, borrowing costs have remained too high and access to new credit severely limited. Not surprisingly, growth and new employment have repeatedly fallen short of objectives.
Two major factors speak to this contrast between theory and practice.
First, the official financing packages have served to subordinate private loans. Due to this subordination, private creditors have shown no appetite to co-finance with the official “troika” of the European Central Bank, the European Union and the International Monetary Fund. Instead, they have used the availability of official financing to exit.
To make things worse, some of this exiting has been accompanied by structural changes that make it highly unlikely that capital will return any time soon. Just witness investment guideline changes that exclude peripheral European economies from the permissible investment universe, and the related credit rating downgrades.
Second, the underlying programmes are yet to strike that delicate balance between budgetary austerity and growth-enhancing measures, including competitiveness-enhancing reforms. This does more than limit countries’ ability to generate future income and be in a stronger position to repay debt. It increases domestic popular resistance to European financial packages, serving also to encourage capital flight by residents (including large withdrawals from bank deposits).
I suspect that these two factors will be at the top of the agenda of Mariano Rajoy, Spain’s prime minister, when he travels to Germany. He has likely been encouraged by recent remarks by ECB and German officials which suggest greater recognition among critical European decision making. But translating this into effective changes on the ground will not be easy.
In a press conference last month, Mario Draghi, the ECB president, indicated that he would look for ways to minimise the subordination problem. This would involve a relaxation of the central bank’s preferred creditor status. But doing so would risk undermining the standing and credibility of an institution that needs safeguards as, almost by definition, it is expected to lend into highly stressed credit conditions.
Shifting the policy balance of the underlying packages is no easy feat either given the time inconsistency between immediate austerity measures and the growth side of the adjustment equation. In addition to complex design issues, this requires even more external assistance at a time when official creditors (and many of their political constituents) are wondering whether they are simply pouring taxpayer money into a deep hole.
European leaders will thus have to work hard to find innovative and imaginative solutions to both these issues. We should all hope that they are successful. If not, Spain’s hesitation will be followed by two new twists in Europe’s crisis: within a few weeks, a significantly larger economy would join three other eurozone members in becoming a ward of the European state; and Italy, an even bigger economy, would risk slipping to where Spain is today.
The writer is the chief executive and co-chief investment officer of Pimco