German Constitutional Court allows Europe to go on its way
As expected, the German Constitutional Court delivered a yes-but verdict on the European Stability Mechanism (ESM) facility, the IMF-plus bailout institution for Europe, being in consonance with the basic structure of the German constitution. With this, Europe is free to go about the complex task of tackling the ever-spreading crisis. The ‘but’ is the share of Germany in the ESM facility not exceeding 190 billion euros without the explicit sanction of the German parliament. Given the German initial paid-up capital share in the ESM being just 22 billion euros, the chances of this getting exceeded are low—under the plan, Germany and other countries will have to pay up their share (190 billion euros for Germany) of the ESM’s 700-billion-euro paid-up capital only if the AAA-rated ESM loses all the 500 billion euros it raises from bond markets. Of course, this is just the beginning, and each adjustment programme for countries will still have to be ratified by the parliament of each member country of the ESM and so isn’t quite a done deal, and we’re not even talking of whether the adjustment will be successful. The programmes are of two types—a full-fledged structural adjustment and a line-of-credit one—but both will have conditionalities like fiscal deficit targets. Any breach of these targets means the country, an Italy or a Spain for instance, will be off-programme and that will mean the ECB’s short-tenure bond purchases—to lower the short-end of the yield curve—will also come to an immediate halt (since the German Bundesbank doesn’t believe the ECB can stop buying bonds once it has begun, it was the sole dissenter on the ECB proposal last week).
While there is no certainty that the ECB-ESM mechanism will work, considerable progress has already been made in Europe where the authorities have already spent 1.7-1.8 trillion euros—1 trillion in liquidity support by the ECB to banks, 200 billion of secondary market purchases of bonds, 200 billion in two Greek packages, 100 billion adjustment programmes for Ireland and Portugal, among others. With the money still left with the European Financial Stability Facility (EFSF), around 700 billion euros of firepower (including the ESM’s 500 billion euros) is still available—a large amount, but quite inadequate for either Italy or Spain if push comes to shove. So far, things look on track with Ireland doing a good enough restructuring to be able to tap the 5-year bond market (at around 5% yields)—yields on Irish debt have halved, making it the poster boy of European recovery. Portugal has more than halved the deficit since 2010 and is committed to achieving the 3% target by 2013, Italy has promised a balanced budget by 2014 and Spain a nearly-balanced budget by 2015. Greece remains a huge problem but, even here, there has been some progress. Of course, though Spain and Italy appear to be reforming, there’s no saying whether either will stay the course—Italian elections are, for instance, due next year and the Greek back-tracking is well-known—since the low-hanging fruit has been harvested already. The other complication is that, with the markets not convinced Germany is fully backing the euro—95% Germans feel the cost is too high—bond yields remain uncomfortably high in the periphery countries.