During a June summit, eurozone leaders discussed a series of proposals aimed at mitigating the effects of the European crisis. These proposals revolved around three key points: the role of the European Central Bank, the role of the European Stability Mechanism (the eurozone's permanent bailout fund), and the creation of a banking union.
In the past few months, Italy and Spain — the two countries under the highest market pressure — have been pushing for two things. First, they want the European Central Bank to resume buying government bonds on the secondary market in order to reduce borrowing costs. The bank has not purchased bonds in more than six months, increasing the pressure on countries to apply the necessary economic reforms to calm markets down. Second, the two are pushing for the European Stability Mechanism to be given a banking license, which would give it access to European Central Bank lending and increase the fund's bailout capacity.
However, there are obstacles to this strategy. The European bailout mechanisms are allowed to buy bonds from member states, but only after countries have formally applied for aid and have agreed to certain fiscal reforms. European Central Bank President Mario Draghi said Sept. 6 that countries asking for assistance must first officially request help from Europe's bailout funds and agree to "strict and effective" budget policy conditions. However, the exact characteristics of such an agreement have yet to be determined. The European Central Bank also has said that giving the European Stability Mechanism a banking license could violate the European Union's treaties, which forbid the bank from lending money directly to national governments.
Many of the fiscally sound northern eurozone countries, led by Germany, do not support their southern neighbors' proposals. German Chancellor Angela Merkel received heavy criticism at home after the June summit on the role of the European bailouts. In smaller eurozone countries like the Netherlands, Finland and Austria, governments are debating the level of European support that troubled countries should receive. The countries in the European core are beginning to feel the effects of the crisis, so their populations are less supportive of providing further bailouts.
The European Union's idea of a banking union is also creating controversy. The proposal has two main features. First, it involves the creation of a shared financial regulator for the biggest eurozone banks. While the European Central Bank is expected to adopt a stronger supervisory role, the eurozone countries have not agreed on the degree of supervision and the enforcement powers that the institution should have. This makes it unlikely that the enhanced supervisory body will be ready by the start of 2013, as initially planned.
The second feature of the proposal is the development of a single-deposit guarantee and capitalization fund for banks. This is the thorniest aspect of the proposal, and it has created controversy since the European Commission first suggested the idea in 2010. Under this system, deposit guarantees in healthy banks could be used to assist troubled banks in other countries. This would mean that funds put aside to guarantee deposits in healthy German banks could be used to guarantee deposits in troubled Spanish banks. The European Commission is expected to present concrete plans for the banking union Sept. 12.
Countries to Watch in Coming Months
The Franco-German Alliance
Collaboration between Germany and France is important to the survival of the eurozone. However, Berlin and Paris are pursuing different strategies to overcome the crisis. Paris supports stronger intervention by the European Central Bank to suppress borrowing costs and relies on heavy government spending and domestic consumption to drive growth. Berlin, on the other hand, is monetarily and fiscally more conservative and is primarily concerned with the health of its exporting industry.
In September and October, core eurozone countries like France and Germany will ratify the fiscal compact treaty requiring eurozone members to implement national legislation that caps budget deficits at 3 percent. Countries will take most of 2013 to implement these reforms, so the concrete effects of the treaty will not be able to be assessed until 2014. However, the ratification of the fiscal compact is essential to Merkel since the promotion of stronger fiscal rules is a key element of Germany's approach to the crisis. If the treaty should fail, Merkel will have greater difficulty getting the German Parliament to agree to further financial aid and deeper integration.
Berlin will maintain its hard-line rhetoric about providing financial aid. However, considering the eurozone's importance to the German economy and the German elections in 2013, Merkel will try to compromise with the peripheral countries. The German constitutional court is expected to give its approval to the European Stability Mechanism on Sept. 12, which would technically allow the European Union to begin using it in bailout negotiations. Once the stability mechanism is operational and the European Central Bank has clarified how it intends to suppress bond yields, Berlin will focus on getting Madrid and Rome to agree to as many fiscal conditions as possible, even though they will eventually receive assistance either way.
EU and eurozone finance ministers will meet Oct. 8-9, Nov. 12 and Dec. 4, and EU members' heads of state will also hold summits Oct. 18-19 and Dec. 13-14. At all of these meetings, the Greek situation and plans for a banking union are likely to be key issues, and Germany's plans for a tighter political and fiscal union will be up for discussion.
These meetings will show the extent to which Paris supports Berlin's plans for a deeper political union. So far, France has supported further intervention by the European Central Bank, but has been less enthusiastic about Germany's plans to cede more sovereignty to EU institutions. Over the past few months, Merkel and French President Francois Hollande have made public statements highlighting their commitment to the preservation of the euro and the need for deeper integration. In the coming months, Paris and Berlin will need to prove the extent to which they are willing to comply with those commitments.
Meanwhile, Hollande will face economic problems at home. The French economy is slowing, causing the president's popularity to decline. Hollande has so far avoided implementing large spending cuts, but Paris will be forced to reduce spending near the end of the year if it is to keep its budget deficit under control.
Germany's Supporters: The Netherlands and Finland
The Netherlands will hold parliamentary elections Sept. 12. No single Dutch party will gain a majority in parliament, so negotiations to form a government will likely be tense. Euroskeptic parties will hold roughly one-third of the seats in the parliament, and the Dutch economy is expected to weaken even further. The combination of these factors will impede Dutch efforts to support Germany in promoting fiscal austerity and further delegation of power to Brussels.
Finland is skeptical of bailouts and further eurozone integration measures that could erode national sovereignty. Therefore, Helsinki will show its opposition to certain aspects of the plans for deeper integration that are to be presented in October. This will create additional obstacles to Germany's institutional designs for the eurozone.
Countries Under Greater Pressure: Spain and Italy
Spain will spend the next quarter dealing with its banking crisis. Madrid's strategy has two parts. First, Spain will finish negotiations for the banking bailout it requested from the European Union. The results of the independent evaluation of the Spanish banking sector, including how much money the sector will need, are expected by late September. According to Spanish Economy Minister Luis de Guindos, the country's banks will need around 60 billion euros ($75.7 billion) of the 100 billion euros the European Union promised.
For the second part of its strategy, Spain will create a bad bank designed to deal with the banking sector's bad debt. According to Spanish media reports, at least 67 billion euros in assets would go to this bank.
Following the formal ratification of the European Stability Mechanism, Madrid likely will come to an agreement with the European Commission and European Central Bank on suppressing Spanish borrowing costs before October, when Spain will be rolling over debt worth around 30 billion euros. Spain is also expected to present its 2013 budget in late September, which will probably include additional spending cuts. In this context, Spanish unions have threatened to organize a general strike to protest the austerity measures.
Italy is also in a delicate situation. On the one hand, Italian Prime Minister Mario Monti shares Spanish Prime Minister Mariano Rajoy's claim that the European Central Bank should intervene in sovereign debt markets. On the other hand, Italy wants to differentiate itself from Spain by convincing markets that the reforms adopted by the technocratic government have made Italy more reliable.
However, Italy's biggest problems are domestic. In the coming months, political activity will heat up in Italy as the main political parties get ready for general elections, which are likely to be held in the first half of 2013. Campaigning will begin immediately after the parties finish discussions over electoral law reform. The center-left's approach will resemble Hollande's campaign in France by promising less austerity and more growth. The center-right is likely to increase its populist rhetoric by upping its criticism of the European Union and Germany's management of the crisis.
Although Stratfor does not expect Italy to follow in Spain's footsteps and ask for a bailout in the coming months, Rome will increase its calls for greater intervention from the European Central Bank in order to keep its own bond yields from surging, since Italy has to roll over 37 billion euros in October and a further 57 billion euros in December.
The Bailout Countries: Greece, Ireland, Portugal and Cyprus
The troika — the European Union, the International Monetary Fund and the European Central Bank — will complete its review of Greece by mid-September. A decision on whether Greece will receive the next bailout tranche (worth roughly 30 billion euros) can be expected for early October. Stratfor expects Greece to receive this tranche after its parliament passes further austerity measures worth 11.5 billion euros in late September. This will buy Greece some time and temporarily ease rumors of its withdrawal from the European Union.
Portugal will likely receive more time to reduce its budget deficit since it has become clear that its economic downturn is stronger than expected. However, Portuguese unions will hold demonstrations across the country against spending cuts and rising unemployment. The main protests are expected for Oct. 13 in Lisbon. Later that month, the government will present the 2013 budget to the Portuguese Parliament, which is likely to generate an uptick in political tensions with the opposition and the unions.
The negotiations between Portugal and the troika will be noted by Ireland, which will be under review by its lenders in October. Ireland will continue to negotiate better bailout terms. If Lisbon is granted softer deficit targets, Dublin is also likely to request — and be granted — special treatment.
Finally, Cyprus will become the fifth eurozone country to receive a full bailout with supervision by the European Central Bank, the International Monetary Fund and the European Commission. Cyprus likely will need around 10 billion euros, most of which will be used to recapitalize its banks due to high exposure to Greece. Nicosia's close ties to Moscow also allow Cyprus to request financial aid from Russia.
Europe's summer parliamentary recess gave eurozone countries some time to prepare their strategies for the final months of the year. With the return to full political activity, Europe will be forced to seek answers to the questions left open after the European summit in June. Since that summit, eurozone members have made little progress in solving the strategic differences between the center and the periphery, and at the same time have struggled to settle disputes within their own political structures. The next four months will test the ability of the bloc's members to overcome their differences and agree on common measures to tackle the financial crisis.
