Time to take action on euro

It is uncertain whether the will exists to take the steps needed to save the currency, says John Walsh

THE immediate focus of the Government will be to get a deal on the bank debt over a series of EU meetings and summits during September and October. Whether it is successful or not will be shaped by factors that will determine whether the single currency has a future. A break-up will have huge implications for this country, but it is far from certain whether the political will exists to take the steps needed to keep the euro together.

Tensions have eased across the eurozone over the past number of weeks on the back of comments made by ECB president Mario Draghi that he “would do whatever it takes to save the euro”. So far the markets have taken him at his word. But there is only so much the ECB can do.

There are two looming flashpoints that will test the resolve of eurozone leaders. The first is the treatment of Spanish banking losses. The second is whether Greece exits the euro.

Either the region melds into some sort of coherent entity that provides a solid base for future growth or there is a disorderly rupture that could presage an economic downturn worse than the crisis that ensued when Lehman Brothers collapsed in Sep 2008.

A working group headed up by Jean Claude Juncker, the president of the Eurogroup of finance ministers, will submit proposals for a banking union. What is proposed and what is ultimately accepted will determine the fate of the euro.

The response to the eurozone debt crisis from the very start had been dictated by the leaders of France and Germany, Nicolas Sarkozy and Angela Merkel.

But the election of Francois Hollande to replace Sarkozy last May stopped the irredentist Merkozy axis in its tracks. Mr Hollande aligned himself with the Spanish and Italians in looking for an alternative to austerity as a way of stemming the crisis.

In June it looked as if this new alliance would reshape the policy contours. At the EU summit on June 29, it was agreed that the capital needed to bail out the beleaguered Spanish banking system could be pumped directly into the banks. When Irish banks went into meltdown, the government was forced to backstop the system, which undermined to solvency of the State and ultimately forced the government to accept an EU/IMF bailout.

If the same template was used for Spain, it would condemn the country and the euro to very bleak futures. Spain is implementing a series of swingeing cutbacks and if it is saddled with the banking losses, then it could trigger a debt deflationary spiral that would be too big to contain.

If the proposed banking union succeeds in breaking the “deadly embrace” between banks and governments then it will go a long way towards drawing a line under the crisis. Moreover, it would provide an opportunity for the Irish Government to reduce the overall debt burden.

However, if there is a backlash by the creditor nations against any form of debt mutualisation, then it could jeopardise plans for a banking union.

If as a result of this backlash, the plans for a banking union are derailed and the Spanish government assumes full responsibility for bailing out its banking system, then it will almost certainly put the economy under unbearable strain. And given that Spain is too big to bail out, then it would almost certainly presage the unravelling of the single currency.

What happens with Greece is also of huge concern. The Greek prime minister Antonis Samaras has requested more time to implement €11.5bn worth of cuts. So far his requests have fallen on deaf ears. The Greek parliament has to ratify the proposed cuts in mid-September. If there is no deal and it is rejected by parliament then the €31bn in the next tranche of bailout funds would be rescinded, which would once again throw Greece’s membership into doubt.

But even if it made sense for Greece to exit, it would set a precedent that would have knock-on effects. If there is a template for an exit, then it would ratchet up market pressure on other periphery countries.

Since the crisis erupted in 2008, eurozone leaders have always found a way to muddle through. Without a central government, the resolution process was always going to be compromised by political horse-trading. But the days of muddling through are over. If decisions are not taken over the next few months, then market forces will take the decision-making out of the hands of the politicians.