Euro Zone - running out of options

Jagath C Savanadasa

The Euro-Zone crisis is subject to such rapid changes that a definitive indication where the zone is heading cannot be predicted.

Late last month (May 27) stock markets in Asia were hopeful that Greece, on the verge of economic collapse, will opt to stay within the Euro Zone and not pull out of it. On the same day another view emanating from European stock markets, observed that the stock markets in Europe were fumbling in anticipation of an imminent Greek pull out.

Angela Merkel	Francois Hollande	David Cameron

Such conflict of views has gone on unabated till this day leading to an air of total uncertainty and confusion. And unless plausible solutions are forthcoming the situation will lead to further turmoil. The big question is, could the world face another major financial crisis?

From the perspective of Sri Lanka, the EU comprising 27 nations is an important market. Though we have not been affected so far since our exports are very small in terms of EU’s total imports, market volatility does not auger well for us too.

The origins of the crisis and the path it has taken are so widely known and so frequently featured in the international press, it does not need recapitulation. Yet a brief look does not seem out of place.

European economies

A little over a year ago under the leadership of Germany, Europe’s strongest economy and supported by France the second in Europe in terms of economic strength, a fiscal pact was negotiated between 17 of the 27 EU nations. The idea was to revive the declining European economies which were deeply into sovereign debt. The most debilitated of such economies were Greece, Spain, Italy, Portugal and Ireland. Whilst pumping billions of dollars through the European Central Bank to revive the banks (and so as to strengthen the governments concerned), the pact also incorporated controls on government spending and budgetary discipline. In other words the Euro Zone was to embark on an austerity drive, which it did.

But the sovereign debt crisis which certain nations faced did not abate. On the contrary it worsened, plunging nations such as Greece into a chaotic state.

Adding to the rising burden of the affected nations was the interest paid by the governments of Spain, Greece and Italy to the banks. In these nations recession was more severe and unemployment had reached record levels.

This led to the swelling belief that it was austerity measures that caused the situation. And across Europe austerity led to public anger and frustration even causing the fall of governments.

The latest in this debacle was France. Nicholas Sarkozy the last French President an apostle of austerity (through his personal life style was one of flamboyance) lost to the Socialist contender Hollande who paradoxically capitalized on anti-austerity sentiment gripping his nation and certain other of the Euro Zone economies.

Euro Zone Pact

Hollande advocates the reverse of austerity, opting for more government spending, a liberal financial climate and investing funds so as to revive the Euro Zone..

Hollande’s anti-austerity stand was supported by the Italian and Spanish Prime Ministers at the last month’s Summit of European nations. This, observers thought was an emerging 'Latin troika' aimed at opposing the German led Euro Zone Pact. The three leaders it was felt, would try to oust the German domination of the Euro Zone and propose its own brand of economic remedy for the ailing Zone. A sort of a master plan, incorporating the issue of Euro bonds to rebuild the shattered economies.

True enough austerity seemingly has not helped in reviving certain European nations. But was it applied rigidly by them or were their economies in a deeply affected state even before austerity was introduced? Take the case of Greece and Italy - both these nations had unstable regimes. They were structurally weak with outdated economic systems with labour laws and taxation. Productivity too was woefully inadequate. Political uncertainty in both these countries too was not conducive to recovery.

But what could plausibly replace austerity which seems a logical remedy primarily centred on controlling state expenditure.

On the other hand why is there a repudiation of austerity measures across the Euro Zone. Could it give rise to extremism among people of the most affected Euro Zone nations? Certainly there are ominous signs of social unrest amongst the unemployed raging across nations such as Greece and Spain. It is one of anger and frustration which seems justified on account of the long suffering of people.

Reflective of anti-austerity sentiment was the most recent electoral swing in the stablest of Euro Zone countries in fact its leader, Germany. In an important election to its most populated state, Rhine - Wesphalia there was a voter swing against the ruling rightist Christian Democrats led by Chancellor Angela Merkel.

But the danger of populist tendencies has been pointed out by the European Commission President Jose Manuel Borroso. In an interview with 'Time' he has stated that extremism could lead to untested populist policy. For example like giving into demands for free spending, loosening Budgetary and financial controls, and total removal of austerity which could spiral Europe into uncontrolled financial mayhem.

Debt ridden countries

Similarly the British Premier David Cameron has pointed out that the extreme left could dominate these countries and form governments. This, he has said could lead to untested populist policies and as the EU President says to financial disaster.

However that may be the very latest outcome of the constant reshaping of policy envisages the relaxation of the Euro Zone fiscal pact and the proposal to form a Euro Zone Bank union instead.

The proposed Euro Zone Bank union is another funding mechanism that would bail out debt ridden countries such as Greece and Spain. The whole idea is to primarily salvage banks which have been crippled by the huge loans given to the state which the latter had been unable to pay back.

Financial system

However, the prime mover of the original fiscal pact Germany has stuck to its guns. On the subject of the new proposal, the reaction of Germany is negative.

Arising from the declining state of affairs could be the worst case scenario which some skeptics fear. This is the likely fall of Greece and if it happen several other weak economies like Italy, Spain and Portugal will perhaps follow suit.

In a bid to forestall such a debacle private creditors were in agreement last week to bail out Greece by cutting its debt by more than a 100 billion Euros. Besides this the IMF and other European Union, governments are also in agreement to provide 160 million Euros for financing Greece until 2014.

Greece out of necessity has to quickly embrace modern economic policies and practices. It has many institutional weakness and systems which simply do not fit in to a modern state. And with its politics heading towards the likelihood of a left leaning government (Greece’s next general elections next held on June 17) there are those who feel that irrespective of Greece being within the Euro Zone or out of it, her economic future is fraught with considerable danger.

According to youthful Alexis Timrix whose Syriza party has a slim chance to emerge winner in the elections or possibly form a coalition with other parties, Greece's future is irrevocably tied to Europe. And Europe he says has a special role to play in the global economic and financial system.

In a statement that seems to be balanced and fair he adds that Greece should adopt a national plan for fiscal reform so as to generate economic growth. But Tripix is a anti austerity player and says that since austerity has not helped the nation thus far it is not fair and logical to insist on the same medicine again.

Whatever is the outcome of this election it is unlikely that Greece could stage a quick recovery. It is also apparent that a concerted action plan in which all major partners of Euro Zone agree to revive the ailing nations is an urgent necessity. But there are now deep cracks within the zone and whether united action is forthcoming in the immediate future remains to be seen.

In a crux the single currency Euro Zone faces a make or break situation. Though there are new forces within the Zone emerging, its future is to a high degree tied to Germany and what that country decides in the main.

Though the United Kingdom is not in the Euro Zone if the Union collapses it will cause a further adverse impact on the UK too which had closed dealings with Euro Zone. UK has now slipped back to recession. All in all as mentioned at the outset uncertainty and confusion makes the picture of the Euro Zone totally unpredictable.

The writer is the Secretary General, Business Chamber of Commerce.

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