Eurozone debt crisis: what will be agreed?

The Mexico summit was dominated by the crisis in the eurozone, with Greece reliant on bailouts from the EU and IMF to keep functioning, Spanish and Italian borrowing costs causing alarm and fears that the single currency could fall apart if a solution is not found that placates the restive markets.

In Greece, the leader of the centre-right New Democracy party, Antonis Samaras, was sworn in as prime minister on Wednesday after reaching a deal to form a coalition government with two left-of-centre parties, Pasok and Democratic Left. The new government will will stick to the austerity programme Greece has agreed with the EU and IMF.

But world leaders, concerned that Europe is moving too slowly, are worried the continent’s woes could drag down their economies.

Aware that domestic opinion is wary of using Germany’s economic strength as the eurozone’s guarantor, Chancellor Angela Merkel has trodden carefully.

She has rejected French President Francois Hollande’s proposals for eurobonds to be issued to raise money and bring down borrowing costs, with the eurozone collectively backing the scheme.

Bailout

Instead, the summit discussed proposals for the EU’s bailout fund, the European Financial Stability Facility (EFSF), to be used to buy government bonds.

The idea is that by intervening in the money markets, the EFSF would bring down the cost of borrowing for countries like Spain and Italy which are being hit by high interest rates.

Borrowing money on the open markets can be prohibitively expensive for governments if investors believe there is a danger they will not receive their money back.

As a result, Spain and Italy are paying the sort of interest rates that forced Ireland and Portugal to turn to the EU and IMF for help.

Spain

The EFSF has already been used to bail out Ireland, Portugal and Greece. Using it to directly buy bonds would be a departure. When it was created, it held 440bn euros, but there are only 250bn euros left and 100bn euros are being made available to Spain to prop up its banks.

There are doubts this will be enough and many believe Madrid will need more money to support its entire economy, rather than just its financial sector.

A permanent bailout fund, the European Stability Mechanism, is also expected to be set up in July. The problem is that the sums needed to provide reassurance that the eurozone’s debts are manageable are eye-watering, and the only country that can offer that reassurance is Germany.

Back at Los Cabos, President Hollande confirmed in his press conference at the G20 that the eurozone is indeed going to activate the EFSF to buy Spanish sovereign debt, maybe as soon as this week. Germany was reluctant to confirm the story, Chancellor Merkel left without a press conference. Read Political Editor Gary Gibbon's blog.

When the EFSF proposals were discussed in Mexico, Angela Merkel was cautious. But the impression given later was that she might be prepared to take some sort of action.

Eurozone leaders meet in Rome on Friday and again in Brussels at the end of June. It is at these meetings that we will have a clearer idea of what is going to happen, but assuming Ms Merkel can be brought on board, a bond-buying programme to help Spain and Italy looks feasible.

These countries’ borrowing costs have already fallen in response to the G20 meeting. With concrete action, the hope is that they will decline again. This would be of immediate benefit to Spain and Italy and would help to convince the markets that the eurozone is making progress.

‘Necessary measures’

A G20 communique says eurozone countries agree to “take all necessary measures to safeguard the integrity and stability of the area”.

It also says the eurozone is considering “concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalisation, and deposit insurance”.

David Cameron said: “They committed to take steps towards fiscal and economic integration including through a banking union.” What this means is more pooling of national sovereignty, with deposits guaranteed across the eurozones in the hope of preventing future bank runs in individual countries.

The European Commission will publish its proposals in the autumn, but this will not be the end of the matter and detailed discussions are likely to continue throughout 2012 and beyond. Nevertheless, a banking union of sorts could be agreed relatively quickly.

Fiscal union

Over the longer term, there is likely to be more fiscal integration. At the moment, the eurozone shares a currency, but nation states decide their own tax and spending policies.

In future, there is likely to be more co-ordination, but once again national sovereignty and public opinion need to be considered.

European Council President Herman Van Rompuy said on Tuesday: “I will propose building blocks for deepening our economic and monetary union so that we can show to the rest of the world and to the markets that the euro and the eurozone is an irreversible project.”

Measures will build on the fiscal compact, adopted in December 2011, that is designed to stop eurozone countries from borrowing too much. In future, eurozone states will have to ensure that budget deficits – the difference between what they spend and raise in taxes – remain within 3 per cent of gross domestic product with automatic sanctions for those breaking this golden rule.

How long will this all take? Although there will be developments in the months ahead, it will be many years before a full blueprint is agreed that, in Mr Van Rompuy’s words, can correct a “policy infrastructure that was too weak for a common currency”.

Achieving a fiscal union would mean changing EU treaties, a tortuous process that can involve referendums in nation states. But with the eurozone’s members co-ordinating their tax and spending policies, Germany could be persuaded that Europe’s debts are for everyone to sort out, rather than just the country that incurred them.

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