Euro area: the way forward Boris KISSELEVSKY, Financial Councellor to the Embassy of France in...

Euro area: the way forward

Boris KISSELEVSKY,Financial Councellor to the Embassy of France in Moscow

Bank of Russia, 17 May 2013

• The 2007 financial crisis, the most severe recession since the 1930s.

• A sovereign debt crisis during the summer of 2011, with its epicentre in the euro area.

• Yet, public finances in the euro area are in better shape than in most other large advanced countries:– How did we get there?– What has been the policy reaction?– What reforms to ensure the success of the euro area?

Introduction

Outline

1. The Sovereign debt crisis, third phase of the financial crisis1. The rise in public debt after the financial crisis

2. The euro area at the epicentre of the sovereign debt crisis

3. Risks of adverse feedback loops

2. Policy answers to deal with the acute phase of the crisis1. Fiscal consolidations plans…

2. …and a strong monetary policy reaction…

3. …achieved stabilisation of the acute phase of the crisis

3. Long term reforms to make the euro area a success1. A new Governance for Europe

2. Financial regulation reform

3. Increasing long-term growth

1. The Sovereign debt crisis, third phase of the

financial crisis

The Sovereign debt crisis, third phase of the financial crisis

1st phase: a financial crisis

Risk aversionRisk aversion common factor

Interbank Risk premium (in basis points)

The Sovereign debt crisis, third phase of the financial crisis

2nd phase: a deep and global economic crisis

-10

-5

0

5

10

15

-10

-5

0

5

10

15

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Zone euro Etats-Unis BrésilJapon Chine

PIB en volume (données trimestrielles, %, ga)

Sources : Eurostat, instituts nationaux (Chine et Brésil)

Derniers points : T3 2011 (sauf Chine T4)

-4,0

-2,0

0,0

2,0

4,0

6,0

8,0

10,0

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010United States France

GDP growth rate(volume, %)

Outline




2. Economic policy answers: the acute phase of the crisis1. Fiscal consolidations plans…






The rise in public debt after the financial crisis

8Lyon – 18 Octobre 2011

Strong use of fiscal policy

-14,0

-12,0

-10,0

-8,0

-6,0

-4,0

-2,0

-

2,0

4,0

6,0

1980 1985 1990 1995 2000 2005 2010

Euro area

Japan

United Kingdom

France

United States

Fiscal balance(in GDP %)

The rise in public debt


A high level of public debt in peace time

0

20

40

60

80

100

120

140

160

180

200

220

240

260

1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000

Public Debt (in GDP % )

1800- 2012

- Unis - Uni Italy FranceUnited States United Kingdom

Fiscal balance 2011 estimates

A better fiscal position for the euro area



A better fiscal position for the euro area

Public Debt – 2011 estimates

Outline










The euro area at the epicentre of the sovereign debt crisis

0

5

10

15

20

25

30

35

40

01/2008 07/2008 01/2009 07/2009 01/2010 07/2010 01/2011 07/2011Austria Belgium Germany Spain Finland France

Greece Ireland Italy Netherlands Portugal

10 years Interest rates- Benchmark (%)


Refinancing needs for Euro area countries (Bns Euros)


Low compliance with the Stability and Growth Pact


-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

2000 2001 2002 2003 2004 2005 2006 2007

Germany France Greece Portugal Italy

Fiscal balance(% of domestic GDP)

Source:CE


Protracted external imbalances


-20,0

-15,0

-10,0

-5,0

0,0

5,0

10,0

2005 2006 2007 2008 2009 2010 2011

Germany France Greece Spain Ireland Portugal

Balance of payments(% of domestic GDP)

Source:OCDE


Strong divergences within the euro area

70

75

80

85

90

95

100

105

110

115

120

70

75

80

85

90

95

100

105

110

115

120

2005 2006 2007 2008 2009 2010 2011 2012

Zone euro France

Allemagne Italie

Espagne Portugal (mm3m)

Grèce (mm3m)

Production industrielle (2005=100, cvs-cjo)

dernières valeurs : janvier 2012 (DE, FR, ES, IT, PT)

décembre 2011 (ZE, GR)

Sources : Eurostat, Insee

Industrial production (2005=100, sa-wda)

Outline










Risks of adverse feedback loops


Lowergrowth

Fiscalsituation

Financial sector

Wor

sen

fisca

l

bal

ance

Less bank

lending

Sovereign risks increase

Higher guarantees

Aut

omat

ic s

tabi

liser

s

held

bac

k

Lower bank

asset quality

Risks of adverse feedback loops

Spillover from sovereign risk to the banking sector

CDS average premium: Sovereign vs banks (in basis points)

Risk of a credit crunch?


-100

-80

-60

-40

-20

0

20

40

60

80

100

03/05 03/06 03/07 03/08 03/09 03/10 03/11France: credit conditions France: credit demandEuro area: credit condition Euro area: Credit demand

Bank lending survey: Credit to firmsNet answers (in % points)

Tightening/Increase

Softening/Decrease

2. Economic policy answers: the acute phase of

the crisis

Outline










Fiscal consolidation

-2.0

0.0

2.0

4.0

6.0

2010 2011 2012 2013

Portugal

automne 2010 printemps 2011 automne 2011

Source: European Commission

0.0

0.5

1.0

1.5

2010 2011 2012 2013

France


Structural effort (% GDP)

Lecture: les tableaux ci-dessous dressent, pour un échantillon de pays de la zone euro, les évolutions de prévision d’efforts structurels. Pour 2012 (dans une moindre mesure pour 2011) l’effort structurel prévu est plus important lors de la dernière prévision, signe que la consolidation est bien engagée.

-2.5-2.0-1.5-1.0-0.50.00.51.01.5

2010 2011 2012 2013

Germany


-2.0

0.0

2.0

4.0

6.0

8.0

2010 2011 2012 2013

Greece


-0.50.00.51.01.52.02.53.0

2010 2011 2012 2013

Spain


0.0

0.5

1.0

1.5

2.0

2010 2011 2012 2013

Italy


Outline










A strong monetary policy reaction


dernière valeur : 14/03/2012

0

1

2

3

4

5

6

7

8

01/01/97 01/01/99 01/01/01 01/01/03 01/01/05 01/01/07 01/01/09 01/01/11

0

1

2

3

4

5

6

7

8

Policy rates

Euro area Eurosystem Eurosystemfrom 28/06/2000 to 8/10/2008

US UK J apan

0%

5%

10%

15%

20%

25%

30%

35%

mars-05 mars-06 mars-07 mars-08 mars-09 mars-10 mars-11

Central banks total assets(Quaterly GDP %)

Japan

Euro area

United Kingdom

United States

Source :BRI Eurostat BoE FED OCDE

Non conventional monetary policy measures

• Measures aiming the banking sector, which finance ¾ of the euro area economy:

• Fixed rate full allotment• Up to 3-year maturity• Extension of collateral requirement

• Direct market purchases to insure a correct transmission of monetary policy:

• SMP: Government securities• CBPP: Covered bonds• OMT: Outright monetary transactions

•STANDARD MONETARY POLICY MEASURES:•Interest rate cuts to historical minimum of 0.75%•but insufficient since markets do not transmit price signals

•NON-STANDARD MEASURES:•Temporary and extraordinary•Complement (not replace) standard measures•Objective: Restore the monetary policy transmission mechanism•by providing liquidity to the banking system through relevant markets:

Interbank money markets Covered bond markets (CBPP1& 2) Debt markets (SMP and OMT)

Eurosystem Response to the Crisis 1/5

Eurosystem Response to the Crisis 2/5

•Measures addressed to the INTERBANK MARKET:•ECB replaces the missing intermediation role of the market

•1. Full allotment policy (since 15 October 2008)• Counterparties have their bids fully satisfied (against collateral)• ensures banks’ continued access to liquidity

• 2. Lengthening of the refinancing operations• 6-month, 12-month and 3-year operations (LTROs)• reduce funding risk of banking system over a longer horizon

• 3. Lower reserve requirement (reserve ratio: from 2% to 1%)• brings down the liquidity needs of banks around EUR100bn

EurosystemResponse to the Crisis 3/5

1st date for3y- LTRO earlyrepayment

0

200

400

600

800

1.000

1.200

1.400

J an 07 J an 08 J an 09 J an 10 J an 11 J an 12 J an 13

EUR bn MRO 1mp LTRO

3m LTRO 6m LTRO

12m LTRO 3y LTRO

Liquidity needs


4. Narrow the corridor set by standing facilities (from ±1% to ±0.75%)

to reduce market rates volatility

5. Increase collateral availability

to avoid collateral shortages, especially in some jurisdictions,

and to foster bank lending, mainly to SMEs and households

• Rating requirement: from A- to BBB-

• Suspension of minimum rating requirement for assets issued/guaranteed by countries under a EU/IMF programme.

• Assets denominated in foreign currency

• Additional credit claims and ABS (securitised credit claims)

6. Liquidity provision in foreign currency (currently USD operations)

Central banks international cooperation key to ease pressures

OUTRIGHT OPERATIONS

COVERED BOND MARKET: Covered Bond Purchase Programmes

to ease funding conditions and encourage lending to clients

CBPP1 (2009/10): 60bn (now 48bn) & CBPP2 (2011/12): 40bn (now16bn)

DEBT MARKETS

Securities Markets Programme (SMP): (May 10/Sep 12)

to address severe tensions in financial markets (currently 206bn)

Liquidity conditions unaffected: absorbing operations (currently 206bn)

Outright Monetary Transactions (OMT): (Sep 12, but not activated yet)

Sovereign bond purchases in the secondary markets (1-3 year bonds)

to repair monetary policy transmission

Subject to strict conditionality: to maintain governments discipline.


Summarising…

BEFORE THE CRISIS DURING CRISIS

(Money) Markets worked wellHigh integration: very narrow spreadsECB interest rate decisions reached the economy evenly across euro area

Dysfunctional (money) marketsUncertainty, liquidity hoarding Market segmentationDifferent rate signals across area

Flexible operational framework: - Large number of counterparties - Broad range of eligible assets - Large refinancing operations

Increase recourse to the ECBFlexibility of the operational framework is exploitedNon-standard measures

Eurosystem provided “only” liquidity needed by the system on aggregateMarginal use of the standing facilities

MRO: key instrument to steer rates (2/3 of the liquidity provided by ECB)

Full allotment policy: liquidity provided driven by counterpartiesVery significant use of std. facilities

>80% of the liquidity currently provided through 3-year LTROs

Looking ahead…

•The flexibility of the monetary policy operational framework•has allowed the Eurosystem to provide the necessary liquidity during•the crisis while maintaining the primary objective of price stability

•Non-standard measures are not the lasting solution to the crisis•but “buy time” for the needed structural reforms• (fiscal consolidation, orderly deleveraging of banks…)

•Phasing-out of non-standard measures? Gradual

•Post-crisis operational framework?•Possibly: core features maintained refined with lessons learnt

Outline










A successful stabilisation

Decrease in sovereign yields

1

2

3

4

5

6

7

8

07/2011 08/2011 09/2011 10/2011 11/2011 12/2011 01/2012 02/2012 03/2012

Belgium Germany Spain France Italy

10-year interest rates - Benchmark (%)


Contrasted situation for countries under programme

0

5

10

15

20

25

30

35

40

45

07/2011 08/2011 09/2011 10/2011 11/2011 12/2011 01/2012 02/2012 03/2012

Greece Ireland Portugal Germany

10-year interest rates - Benchmark (%)

A decrease in banking risk


-6

-4

-2

0

2

4

6

8

janv.

-10

mar

s-1

0

mai

-10

juil.

-10

sept.

-10

nov.

-10

janv.

-11

mar

s-1

1

mai

-11

juil.

-11

sept.

-11

nov.

-11

janv.

-12

France

Allemagne

Espagne

Italie

Zone euro

Non financial corporations

-5

0

5

10

janv.

-09

avr.

-09

juil.

-09

oct.

-09

janv.

-10

avr.

-10

juil.

-10

oct.

-10

janv.

-11

avr.

-11

juil.

-11

oct.

-11

janv.

-12

France

Allemagne

Espagne

Italie

Zone euro

12-months change (%) (gross; not corrected for securitisation for housing loans)

Housing loans

Impact on credit to be confirmed

3. Long term reforms

Outline










European Governance overhaul

1/ A strengthening of the Stability and Growth Pact

2/ Economic imbalances surveillance

3/ A framework for the crisis management

A strengthening of European Governance


A strengthening of ex ante surveillance :• The European semestre• The golden rule• Structural deficit below 0.5% of GDP• Debt reduction:1/20th a year above 60% of GDP

More automatic sanctions ex post:

• Reverse qualified majority at all stages of the excessive deficit procedure

• Infra-annual surveillance

• Progressive sanctions up to 0.5% GDP fine

A strengthening of the Stability and Growth Pact


• A yearly scoreboard prepared by the Commission:• External imbalances:

• Balance of payment• Net investment position• export market shares• unit labour costs• effective exchange rates

• Internal imbalances:• Public and private indebtedness• Housing prices• Unemployment

• European Council Recommandation in case of excessive imbalances

• The Member-State presents a corrective action plan

• Sanctions in case of insufficient action plan

Surveillance of economic imbalances


• For France, 2 surveillance points:

• export market shares: -19 points in 5 years/ 6% threshold

• Public Debt: 82% / 60% threshold

• In-Depth study for 12 Member-States, among which France

• 4 Member-States under programme (Ireland, Portugal, Greece and Romania) already under strengthened surveillance.

Surveillance of economic imbalances


• A credible stabilisation mechanism « firewall »:

• European Financial Stability Fund (EFSF - June 2010): 440 Mds €

• 192 Mds for Greece, Ireland and Portugal

• 109 Mds additional for Greece

• Leverage?

• European Stability Mechanism (ESM – july 2012): 500 Mds €

• Conditionality

• Interest rates close to EFSF funding costs

• Prevent spillovers and insure financial stability

A permanent framework for the crisis management

Outline










• Increase capital requirement for market operations

• Increase the quality and quantity of capital

• Reinforce and harmonise liquidity regulation

• Regulate bonuses

•BANKING UNION

Financial regulation reform

A global reform of banking regulation…

…a reform to be extended to the financial system

• Regulation of Systemic Financial Institutions:• Enhanced loss absorption capacity (G SIB)• Restructuration mechanism and enhanced supervision• Extending G SIB to all systemic institutions

• Market risks:• Standardisation of complex financial products• Compensation by regulated central conterparts• Better supervision of shadow banking, in particular hedge funds


A new macroprudential surveillance

• Macro-prudential surveillance :

• Complement microprudential supervision

• Take into account interconnexion between institutions, markets, instruments and risks accumulation.

• For example: preventing housing bubbles

• A new institutional framework:

• Financial stability board and IMF at a global level

• In the US, Financial Stability Oversight Committee (FSOC)

• In Europe, European Systemic Risk Board (ESRB)

• In France, creation of the « Autorité de Contrôle prudentiel » under the aegis of Banque de France and of the COREFRIS


A new European system of financial supervision


Outline










Which impact on potential growth?

Advanced countries: towards a lower potential growth

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

6,0

-8

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013

PIB (% an)

Japon

Etats-UnisZone euro

Source : FMI

Prévisions FMI WEO (Update janvier 2012)

UK

Increasing long-term growth

Europe 2020 Strategy for a smart, sustainable and inclusive growth

• A smarter growth: digital economy, innovation, education• A more sustainable growth: low-carbon economy ; improving the business environment• An inclusive growth: raising Europe’s employment rate, investment in skills & training, European platform against poverty.

2010 Goal Employement rate (20-64 year-old) 68,6% 75% R&D domestic gross expenses 2% 3% Greenhouse gas emissions, 1990 base year 83%* 80% Share of energy from renewables 11,7%* 20% increase in energy efficiency (kg oil equivalent per 1 000 Euro of GDP) 165,2* 132,2 Reducing school drop-out rates (% of 15-24 year-old) 14,1% 10% Completing third level education (% of 30-34 year-old) 33,6% 40% People in or at risk of poverty and social exclusion (in ‘000) 115 479 -20 000

2010 key - indicators and goals

• Negative feedback loops have been interrupted by fiscal consolidation plans and strong monetary policy measures.

• In the medium term, three priorities:

– Implement European governance reforms

– Carry on banking regulation reforms (Banking Union and banking resolution mechanism)

– Increase long-term growth

Conclusion

Euro area: the way forward Boris KISSELEVSKY, Financial Councellor to the Embassy of France in...

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