Parthasarathi Shome: Has the euro matter now been solved?
The euro zone should consider allowing countries to leave and rejoin.
For the first time, it appears that the European Union (EU) has taken an appropriate structural measure in their recent meeting in Brussels that could allay market fears for a time. They have decided to create, with haste, a Euro 500-billion European Stability Mechanism as early as July 2012. It will be permanent, and perhaps would be able to borrow directly, as needed, from the European Central Bank. In a complementary, confidence-seeking short-term gesture, they also agreed to ask their respective central banks to give the International Monetary Fund (IMF) Euro 200 billion to buttress the Euro 440-billion European Financial Stability Facility. These do represent moves in the right direction, and should enable these institutions to quickly come to the rescue of their ailing members.
What self-imposed belt tightening would the 17-member EU undertake? They have agreed to more centralised oversight and control of the fiscal budgets of individual countries, and possible sanctions for countries that break public debt understandings. Diagram 1 reveals the continuation of higher than trend fiscal deficits in selected EU economies, and the need for correction. However, only time will tell if they would, or could, adhere to agreements this time. Recall that, after all, the Big Two broke the Maastricht Treaty guideline of a three per cent fiscal deficit with respect to GDP. Regarding a public debt ceiling, Diagram 2 indicates the scale of the problem in 2011 compared to 2007, and the need for rules.
But these rules cannot be designed with a cookie-cutter. A lacuna for imposing a single fiscal rule for all of the EU is that, in practice, economists know well that the same fiscal deficit-to-GDP ratio leads to different multiplier effects in different economies — depending on their particular characteristics, such as trade openness, exchange rate regime, stage of development and others. Despite empirical evidence to the contrary, if the EU decides to re-deploy the generic flawed criterion/indicator that they have already broken in the past, and then expect that Moody’s or other rating agencies would suddenly retreat from downgrading some of their economies, it would be fallacy. Instead, the rules would have to be designed for each country through IMF-type programmes. The Fund should revert to traditional financial programming and apply a modified and improved version across the board, rather than being perceived as selective. Clearer signals are needed that the EU too is willing to consider the acceptance of such individually-guided, corrective programmes for its member countries.
The consideration should, therefore, remain on the table that euro zone members that have no realistic long-run alternative but to severely curtail domestic consumption and lurch into an export-driven recovery might move off the euro and devalue — in the process countering somewhat the undervaluation of selected Eastern currencies. In effect they would be like the UK, being a part of the EU but not of the euro zone. Diagram 3 illustrates selected figures for cross-country balance of payments; it should make obvious where the need for continuing correction lies, even though between 2007 and 2011, adjustments among surplus and deficit countries have indeed occurred.
Once solidly on the path to recovery, the exited EU members should be able to rejoin the currency union equally smoothly. Arguments that such a course – comprising altering membership of the euro zone, and presumably more fluctuations in the currency itself – might cause disruptions in the global trade and payments system is post facto. The rapid fluctuations in relative exchange rates with respect to the euro are already challenging lines of credit arrangements and causing discomfort for future, trade-dependent business plans.
The fact that the UK is basically staying out of the newly-reached understandings is a good sign. It should follow its conservative fiscal policies. There should be no surprise that it has been a slow process for it to pick up on the growth rate. The severe belt-tightening that it has opted for is akin to that of Korea, which voluntarily did the same after the 1997-98 East Asia crisis. It served Korea well. If the UK clings to its current fiscal path, it will emerge stronger in the longer term, and with less of a burden on posterity.
In the same vein, any speculative debate over how to resurrect GDP growth quickly is not based on realism since this is not an achievable short-term scenario. Diagram 4 shows recent GDP trends. These economies should be guided to accept that not only has there been a dive in their GDPs, but the future trend GDP growth rates will be lower than past trends for some time to come. How long it will take to get back on the pre-2007 rate path will depend on how much they are willing to tighten their belts and leave more of their product for export. They can achieve this at realistic exchange rates, rather than be seen as continuing to need bailouts. Markets have perceived the short-sightedness of continuing with the previous century’s East-West divide in economic ratings, with lopsided prescriptions for correction primarily on one side. Commensurately, rating agencies have become less and less oblivious and forgiving.
A final word. There remains little option for the EU but to infuse confidence among its counterparts in the G20. Their mettle will be proved with the strength of correction that they actually undertake, rather than with their mere agreement to take action. The world can wait until the summer of 2012 — but not too much longer.
The writer is Director and Chief Executive, Icrier, New Delhi. The opinions expressed here are his own