Wednesday, February 1, 2012

How soon is EU breaking apart?

Another EU summit was concluded earlier this week and an important agreement (?) was reached.  New pact tightens the leash on fiscal policy in Euro zone countries; deficits should be no more than 0.5% of  GDP and the Governments would have to pledge to maintain balanced budgets into their constitutions. Violators could now be sanctioned by the European court of  Justice. This fiscal discipline is intended to keep the pressure on Italy, Spain, Greece and other troubled countries. EU leaders have agreed to bring out the EU's permanent bailout fund ahead of schedule; there are also talks of spurring growth and creating jobs.

However, there are some nagging concerns (1) there is no talk of increase in size of the bailout fund, which seems necessary to build strong firewalls against defaults (2) with austerity measures (tax hikes and reduction in budget spending), growth could be a big challenge (3) unemployment in the region is already at euro-era high; if growth prospect looks bleak, job creation looks bleaker (4) clarity is missing as to what this fiscal pact would do to address euro zone's debt problem today (5) Austerity led reform may not necessarily be the way forward - Portuguese which has been earnestly trying to implement reforms has not gone very far (it's 10 year T-bills yield is around 16%!!!) and may soon be lining up for a second bailout.

Fact remains that, there is going to be no easy way out.  Even though there is no assured prize (read no risk of default) for implementing and practicing austerity, troubled European countries are not left with much choice.  Germany's Chancellor Merkel is pushing  EU members to bring about fiscal discipline first for she knows that some of the nations would simply not pursue meaningful reforms once / if they got bailed out of their debt crisis.  

It is also a fact that fiscal pact that is being doctored is no remedy for current crisis;  some of the economies need much stronger boosters.  In the absence of willingness to address this economic reality, no amount of fiscal convergence and economic / political reforms would help.  A classic catch 22 situation.  It looks like some of these debt laden countries will exit the union sooner than we think!

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