Opinion If Berlin shrugs

Merkel is obviously buying time as things are getting too hot for her back home. The German parliament,Bundestag,is increasingly uneasy about the events overtaking the eurozone. Last week,Germany’s constitutional court ruled that the government had not consulted the parliament sufficiently about the permanent bailout scheme to be launched on July 9,called the European Stability Mechanism,(ESM),with a corpus of $620 billion. Parliaments in 17 euro currency nations will have to ratify this fund so that it could be used to counter the financial crisis in Greece and other countries.

The ESM is to receive contributions from all 17 nations. The crisis-ridden economies of Portugal,Ireland,Greece and Spain (PIGS),for instance,have to contribute about $100 billion. But eurozone is in such a state of flux that the PIGS are drawing down huge amounts from a temporary bailout fund even before making their own contribution to the ESM. In effect,that puts over 75 per cent of the burden of the ESM corpus on Germany and France. This is precisely what the German people and the parliament will question in the weeks ahead.

The Bundestag president,Norbert Lammert,welcomed the German constitutional court verdict as “it would strengthen the role of German parliament in the European decision-making process”.

In short,the German parliament will watch its government’s moves very carefully,not a very comforting thought for Merkel. For the eurozone,the next big hurdle to cross is the formal establishment of the ESM,which is seen as the centrepiece of Europe’s proposed $1 trillion firewall to stave off a bigger financial contagion arising from the sovereign debt crises that are shaking world markets now.

While the ESM is yet to be formally ratified by the euro currency nations,there is talk of creating two new funds — one to guarantee insurance for depositors in banks across the euro region and the other to act as a lender to banks that may show signs of going belly up. This idea gathered momentum after the biggest Spanish bank,Banco Santander,almost went under and threatened a contagion across the region.

Merkel was not very responsive to the idea of creating two new funds simply because she is not sure how the country will react to additional bailout mechanisms in which Germany will obviously have to contribute the largest share.

The European leaders at the G-20 last week pledged to take all necessary policy measures to safeguard the “integrity and stability of the area,improve the functioning of financial markets and break the feedback loop between the sovereigns and the banks”. This is easier said than done. Ever since the mega banking crises in the United States,which subsequently spread to Europe in 2009,one thing has become crystal clear. We are in a vicious cycle where the balance sheets of both banks and governments are getting soaked in red. Governments are borrowing heavily to bail out banks and the ballooning sovereign debt is causing fresh problems for the banks that had been bailed out earlier. In a way,the problem shifts from bank balance sheet to the government balance sheet and then comes back to the bank balance sheet as the economy remains permanently in non-recovery mode due to excessive debt to GDP ratios.

The worry is not that most of the eurozone economies are in a mild recession. That has been known for some time. The real worry is that Germany,its strongest engine,is showing signs of slipping into a recession. If that happens,all hell will break loose and it will become difficult for the political class in Germany to convince its parliament about the magnitude of the financial burden that Germans may be expected to share. The eurozone experiment will probably begin to unravel at that stage. As long as the German economy remains reasonably strong,things could still be salvaged.

Therefore,politically,the big risk is not Greece wanting to exit the eurozone at some stage. The real risk will arise when Germans start making a noise about exiting the euro,even if that prospect appears somewhat remote now. Today,the German parliament needs to be convinced about a sustainable bailout mechanism that is administered autonomously. Merkel was harping precisely on this at the mini summit last Friday.

The eurozone members,with their backs to the wall at the G-20 meet,appreciated the fact that action on the ground could no longer be postponed. They fully supported the urgent need “to consider concrete steps towards a more integrated financial architecture,encompassing bank supervision,recapitalisation and deposit insurance”. Fortunately,this statement reveals that the eurozone nations have read the writing on the wall. Their piecemeal approach so far hasn’t worked.

For the first time they have chosen to partially move towards a fiscal union by agreeing to follow an integrated approach to bank capitalisation. This means all big banks in the eurozone will be capitalised by a centrally funded mechanism and these banks will operate independent of their respective governments. Inherent in the notion of a banking union,which the eurozone leaders have agreed to,are the beginnings of a possible fiscal union at a later stage. However,the euro leaders must clinch this sooner rather than later. So far,they have allowed events to overtake them. This crisis requires vision that is followed by decision-making with speed and agility. The euro members could regain some of their lost global economic leadership by acting fast.

The writer is managing editor,‘The Financial Express’,mk.venu@expressindia.com