.
By Shavasb Bohdjalian
The EU Summit accord according to which 26 member states except for Britain will pursue stricter budget rules have failed to impress financial markets.
The lack of specifics is probably the reason why markets are not impressed, because as usual there is almost no mention of policies aimed at boosting growth, no specific action plan on how core Europe will aid the peripheral and no accord on how the ECB will become involved in aiding cash-strapped and debt ridden nations.
EU leaders agreed to lend up to EUR200 bln to the IMF to help it aid euro zone strugglers, and to bring forward the permanent rescue fund European Stability Mechanism (ESM) by a year to mid-2012. Those steps, together with a leveraged EFSF – the existing bailout fund – are intended to help troubled euro zone countries. Italy alone has EUR150 bln in debt falling due between February and April of next year, according to a Reuters analysis.
The fact that the ECB said it is capping its weekly purchases of Italian and Spanish bonds at EUR 20 bln is another slap in the face of EU leaders. More worrisome is the fact that the volume of the bailout fund is not sufficient to safeguard the risk of contagion since the fund was not granted a banking license, which would give the ECB the pretext to lend it much larger amounts for intervention.
"Near-term, there remains inadequate firepower to backstop large euro-area sovereigns; we expect that a reluctant ECB will eventually have to adopt this role," Standard Chartered wrote in a note to clients.
Until the funding scheme is strengthened further, financial strains will persist, as worries about banks' exposure to euro zone sovereign bonds have made them reluctant to lend dollars to each other, Reuters quoted unnamed officials as saying.
Banks, pressed to beef-up their capital hit by plunging euro zone bond prices, could face additional pressure if rating agency Standard & Poor's follows up on its decision after placing all euro zone sovereigns on creditwatch negative.
There is no doubt that progress has been made since it’s obvious that EU leaders led by Germany and France are taking necessary measures to fix the flaws of monetary union which could not function without coordinated budget policy. But the process will be long and slow to give results.
And as nations now rush to balance their budgets, their first act is to cut expenditure, curtail development budgets and increase taxation. The problem is that after making the relevant cuts, the balanced budget issue will not be solved since tax revenue in fact decreases in periods of economic contraction.
Greece is a classic example of this since while it has been cutting expenditure, its budget deficit continues to grow following a plunge in tax revenue. Cyprus, Spain, Italy and Portugal all face the same risk since declining tax revenue will force governments to proceed with even more belt tightening.
EU26 were absolutely right however to allow Britain to become isolated since it is about time that they imposed financial penalties on the banks for causing the current crisis due to reckless speculation and risk taking, all because bank management are only interested to fill their pockets with bonuses.
The reason why the euro is not declining aggressively is because the market and speculators are already heavy short, while stock markets generally will be climbing as the ECB maintains a loose monetary policy and keeps reducing interest rates. With investors not trusting the banks with their money and faced with the prospect of low interest rates, they are more likely to invest in the stock market and bonds.
www.eurivex.com
[email protected]
(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10 and approved by the Cyprus Stock Exchange to act as Nominated Advisor for listings on the Emerging Market. The views expressed above are personal and do not bind the company and are subject to change without notice)
