THE LESSONS/ POLICY RESPONSES AND THE FUTURE OF THE EURO

Maja Kadievska VojnovikVice-governor

National Bank of the Republic of Macedonia

Outline:

The lessons from the Eurozone (EZ) crisis /policy responses

1.Growth model of GIIPS2. Problems in the structure of the EZ3. Mispricing of risk by capital markets4. Crisis prevention and resolution mechanism

needs to be in place before the next crisis5. Surveillance and monitoring of regional financial

markets should be strengthened6. Banks need to be recapitalized quickly after crisis The future of the Euro

1. Growth model of GIIPS

The growth model of GIIPS (Greece, Ireland, Italy, Portugal and Spain) based on:

Large external imbalances -large CAD financed by debt-creating flows;

The falling labor productivity and rising labor costs;

Lavish social security systems with inefficient governments - high and permanent deficits

is NOT SUSTAINABLE.Solution: Austerity Programs and Structural

Reforms!!!

1. Growth Model -Large wage increases in excess of productivity

growth/rising ULC

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

20

40

60

80

100

120Unit Labor Costs (index base year 2005=100), 1990–2010

Greece Italy Spain Ireland German France

Source: OECD

1. Growth Model - The appreciation of

REER impaired export performance

03/2

003

06/2

003

09/2

003

12/2

003

03/2

004

06/2

004

09/2

004

12/2

004

03/2

005

06/2

005

09/2

005

12/2

005

03/2

006

06/2

006

09/2

006

12/2

006

03/2

007

06/2

007

09/2

007

12/2

007

03/2

008

06/2

008

09/2

008

12/2

008

03/2

009

06/2

009

09/2

009

80

85

90

95

100

105

110

115

120

Real Effective Exchange Rates Based on Relative Unit Labor Costs, 1990Q1–2011Q1

Greece Italy Spain Por-tugal Ireland German France

Source: IMF

1. Growth Model- Worsen competitiveness vis-à-vis the core countries, in particular

Germany, caused large CAD

199019911992199319941995199619971998199920002001200220032004200520062007200820092010-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00 Current Account % of GDP

Greece

Spain

Portugal

Ireland

Italy

Germany

France

Source: IMF

1. Growth Model -Global financial crisis of 2008–2009, spilled over into

a sovereign debt in early 2010

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-30

-25

-20

-15

-10

-5

0

5

10 Budget deficit as % GDP

Greece Italy Spain Portugal Ireland German France

Source: Eurostat

1. Growth Model -Government bailouts of banking systems contributed to an increase in already high public debt

levels

Greece Italy Spain Portugal Ireland Germany France0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0Public Debt as % of GDP

19952001

Source: Eurostat

A common monetary policy and currency without fiscal union, centralized budget authority or system of fiscal transfers across members to smooth out asymmetric shocks;

Solution: European Governance Reforms

In December 2011, announced a new "Fiscal compact“: Introduction of fiscal rules in national constitutions -the structural

deficit not exceed 0.5% of GDP; European Court of Justice (Luxembourg) will be responsible for the

proper transposition of this rule; Introduction of automatic sanctions for countries that violate the

rules of the Stability and Growth Pact (deficit ceiling of 3% and the debt ceiling of 60%)automatic sanctions (0.2% of GDP, blocking money from the Structural Funds);numerical benchmark for the debt (1/20 to reduce annual average calculated for three years);

2. Problems in the structure of the Eurozone

3. Mispricing of risk by capital markets

European monetary unification brought convergence of interest rates among EZ members, but the financial integration did not automatically lead to the efficient allocation of capital.

Solution: the risk assessment on country level

3. Mispricing of risk by capital markets -Since March 2010, the borrowing costs

for the GIIPS increased significantly

01/2

007

03/2

007

05/2

007

07/2

007

09/2

007

11/2

007

01/2

008

03/2

008

05/2

008

07/2

008

09/2

008

11/2

008

01/2

009

03/2

009

05/2

009

07/2

009

09/2

009

11/2

009

01/2

010

03/2

010

05/2

010

07/2

010

09/2

010

11/2

010

01/2

011

03/2

011

05/2

011

07/2

011

09/2

011

11/2

011

01/2

012

0

5

10

15

20

25

30

35

40

10 Year Government Bond Yields, January 2007–January 2012

Greece

Italy

Spain

Portugal

Ireland

Germany

France

Source: Bloomberg

3. Mispricing of risk by capital markets The cost of insuring sovereign debt

against default soared

12/2

007

03/2

008

06/2

008

09/2

008

12/2

008

03/2

009

06/2

009

09/2

009

12/2

009

03/2

010

06/2

010

09/2

010

12/2

010

03/2

011

06/2

011

09/2

011

12/2

011

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000Greece - Sovereign Credit Default Swaps, December

2007–January 2012

12/2

007

04/2

008

08/2

008

12/2

008

04/2

009

08/2

009

12/2

009

04/2

010

08/2

010

12/2

010

04/2

011

08/2

011

12/2

011

0

200

400

600

800

1000

1200

1400

1600

Italy

Spain

Por-tugal

Ireland

German

France

Credit Rating by Countries 2007/2012

    Greece Italy Spain Portugal Ireland German France

2007

Moody's A1 Aa2 Aaa Aa2 Aaa Aaa Aaa

S&P A A+ AAA AA- AAA AAA AAA

Fitch A AA- AAA AA AAA AAA AAA

2012

Moody's C A3 A3 Ba3 Ba1 Aaa Aaa

S&P SD BBB+ A BB BBB+ AAA AA+

Fitch B- A- A BB+ BBB+ AAA AAA

Source: Bloomberg

4. Crisis prevention and resolution mechanism needs to be in place before the next

crisisSolution:Temporary, three-year lending facility-

European Financial Stability Facility (EFSF), but more importantly - Permanent rescue fund, the European Stabilization Mechanism (ESM) in 2013.

In 2012, EFSF and ESM will overlap with total ceiling of 940 billions euro

 

Date agreedEuropean Financial Assistance

IMF- Financial Assistance

Total Financial Assistance

GREECE May 2010 € 80 billion € 30 billion € 110 billion

IRELAND December 2010 € 45 billion € 22.5 billion € 67.5 billion

PORTUGAL May 2011 € 52 billion € 26 billion € 78 billion

GREECE July 2011/ February 2012 € 130 billion   € 130 billion

Financial Assistance from other EZ governments and IMF

Source: IMF

5. Surveillance and monitoring of regional financial markets should be strengthened

Solution: New supervisory framework: As from January 2011, the three European

supervisory authorities (ESAs) and a European Systemic Risk Board (ESRB) were established to replace the former supervisory committees:

European Banking Authority; European Securities and Markets Authority, European Insurance and Occupational

Pensions Authority.

6. Banks need to be recapitalized swiftly after crisis The 2008-2009 financial crisis had deepen the already

unsustainable fiscal positions; the sovereign debt crisis since the 2011 summer has triggered a dangerous feedback loop.

Solution :Consensus on banking package for restoring confidence

Guarantees on bank liabilities -to provide more direct

support for banks in accessing term funding (as essential part of the strategy to limit deleveraging actions);

The repetition of the 2008 experience with full national discretion in the setting-up of liquidity schemes may not provide a satisfactory solution under current market conditions. Therefore a truly coordinated approach at EU-level is needed regarding entry criteria, pricing and conditions.

Capitalisation of banks : Quantitative capital target of 9 % have to be attained by 30 June 2012, based on plans agreed with national supervisors and coordinated by EBA.

National supervisory authorities, under the auspices of the EBA, must ensure that banks’ plans to strengthen capital do not lead to excessive deleveraging

Financing of capital increase: Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments.

Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained.

If necessary, national governments should provide support , and if this support is not available, recapitalisation should be funded via a loan from the EFSF in the case of EZ countries.

Any form of public support, whether at a national or EU-level , will be subject to the conditionality

  Country The major banks by assets size   Germany Deutsche Bank AG Commerzbank AG DZ Bank AG

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aaa AAA AAA Aa1 AA AA- Aa3 A A Aa3 A+ A+201

2 Aaa AAA AAA Aa3 A+ A+ A2 A A+ Aa3 AA- A+  France BNP Paribas SA Credit Agricole SA Societe Generale

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aaa AAA AAA Aa1 AA+ AA Aa1 AA- AA Aa1 AA AA201

2 Aaa AA+ AAA Aa3 AA- A+ Aa3 A A+ A1 A A+

  Spain Banco Santander SABanco Bilbao Vizcaya

Argentaria SA Bankia SA

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aaa AAA AAA Aa1 AA AA Aa1 AA- AA-  201

2 A3 A A Aa3 A+ A Aa3 A A Baa3 BBB- BBB+

  Italy UniCredit SpA Intesa Sanpaolo SpABanca Monte dei Paschi di

Sienna Spa

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aa2 A+ AA- Aa2 A+ A+ Aa2 AA- AA- Aa3 A A+201

2 A3 BBB+ A- A2 BBB+ A- A2 BBB+ A- Baa1 BBB BBB

  PortugalCaixa General de

Depositos SABanco Comercial

Portugues SA Banco Espirito Santo SA

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aa2 AA- AA Aa1 A+ AA- Aa3 A A+ Aa3 A A+201

2 Ba3 BB BB+ Ba2 BB- BB+ Ba3 B+ BB+ Ba2 BB-  

  IrelandMerrill Lynch International

Bank Limited AIB Group Depfa bank plc

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 Aaa AAA AAA A1 A+ Aa2 A+ AA- Aa3 A+ AA-201

2 Ba1 BBB+ BBB+ Baa1 A Ba2 BB BBB Baa3 BBB BBB+

  GreeceNational Bank of Greece

SA EFG Eurobank Ergasias SA Alpha Bank AE

 Moody'

s S&P Fitch Moody's S&P Fitch Moody's S&P Fitch Moody's S&P Fitch200

7 A1 A A Aa3 BBB+ A- Aa3 A- A A1 BBB+ A-201

2 C SD B- Caa2 CCC B- Caa2 CCC B- Caa2 CCC B-

Source: Bloomberg

European Banks’ Sovereign Debt Exposure

(in million EUR)

BNP Paribas SA

Credit Agricole

Societe Generale

Deutsche Bank AG

Commerzbank AG

Banco Santander

Banco Bilbao Vizcaya Argentaria

UniCredit SpA

Intesa Sanpaolo SpA

National Bank of Greece SA

EFG Eurobank Ergasias SA

Alpha Bank AE

-

2,0

00

4,0

00

6,0

00

8,0

00

10,

000

12,

000

14,

000

Greece

BNP Paribas SA

Credit Agricole

Societe Generale

Deutsche Bank AG

Commerzbank AG

Banco Santander

Banco Bilbao Vizcaya Argentaria

UniCredit SpA

Intesa Sanpaolo SpA

- 10,000 20,000 30,000 40,000 50,000 60,000

Italy

BNP Paribas SA

Credit Agricole

Societe Generale

Deutsche Bank AG

Commerzbank AG

Banco Santander

Banco Bilbao Vizcaya Argentaria

UniCredit SpA

Intesa Sanpaolo SpA

- 50 100 150 200 250 300 350 400

Ireland

BNP Paribas SA

Credit Agricole

Societe Generale

Deutsche Bank AG

Commerzbank AG

Banco Santander

Banco Bilbao Vizcaya Argentaria

UniCredit SpA

Intesa Sanpaolo SpA

- 500 1,000 1,500 2,000 2,500

Portugal

BNP Paribas SA

Credit Agricole

Societe Generale

Deutsche Bank AG

Commerzbank AG

Banco Santander

Banco Bilbao Vizcaya Argentaria

UniCredit SpA

Intesa Sanpaolo SpA

- 10,000 20,000 30,000 40,000 50,000 60,000

Spain

European Banks’ Sovereign Debt Exposure

(in million EUR)

“The euro is at the core of our European project of peace, stability and prosperity. We agreed today on a comprehensive set of measures to restore confidence and address the current tensions in financial markets. These measures reflect our unwavering determination to overcome together the current difficulties and to take all the necessary steps towards a deeper economic union commensurate with our monetary union”.

Euro Summit (Brussels 26 October 2011)

The Future of Euro The policy commitment

The Future of Euro The policy responses criticized as too

little and too late Disagreements among EZ core countries and

ECB over the appropriate response; Slow and complex EU policy-making process; Domestic political obstacles/ number of protests

and fall of many governments ; Political resistance to providing financial support

to countries in trouble/ critics opposed to the idea of rescuing countries without adequate budget discipline.

ECB Support: In May 2010, the ECB began buying government

bonds on secondary markets in an attempt to stabilize bond yields;

The flexibility in its short-term refinancing operations was increased (accepting the securities, including government bonds, with lower credit ratings).

Long-term refinancing operations (LTRO):1. In December 2011, providing loans to more than

500 Eurozone banks, totaling €489 billion2. In February 2012, which was even bigger, totaling

an additional €530 billion and had more than 800 banks participating.

Policy measures - ECB

Policy measures – Private sector involvment

Losses on Greek Bonds;

The biggest sovereign-debt restructuring ever, covering €206 billion of debt, holders of €172 billion of bonds agreed. Collective-action clauses boost the participation to €197 billion, 96% of the total, triggering credit default swaps. With this, Greece gets its second bailout.

The Future of EuroPossible only if: The policymakers address the underlying

causes – past and future imbalances in the EZ;

Fiscal consolidation in EZ and painful structural reform in the periphery are successfully completed;

For the EZ crisis to be over (in the absence of Eurobonds or fiscal transfers), some of Europe’s debt would need to be written down;

The sovereign banking feedback loop need to be broken and

The EZ would need to have a credible growth strategy going forward.

THANK YOU!