The world is waiting for Godot. Unlike the famous Samuel Beckett play, we all know who our Godot is—he’s the collective heads of the 27 nations that make up the European Union, who’ll be meeting on 9 December to decide the fate of the euro zone. Will they be able to save Euroland, and, with it, the world economy? What will happen if they don’t? The dialogue in Beckett’s play is rather similar:
“Vladimir: We’ll hang ourselves tomorrow. Unless Godot comes.
French president Nicolas Sarkozy (left) with German Chancellor Angela Merkel.
Estragon: And if he comes?
Vladimir: We’ll be saved.”
The markets, of course, are expecting salvation. The MSCI EMU index, which reflects the common currency area, is up 6.5% in local currency terms in the three months to 6 December. After a period of existential angst, racked by feelings of despair and abandonment about the ability of governments and central banks to come up with a solution, the mood has turned. Contrast MSCI India, up a mere 1.2% over the three months to 6 December.
The broad outline of what is to be expected at the summit was expressed by European Central Bank (ECB) president Mario Draghi in a speech to the European parliament on 1 December. He called for “a new fiscal compact—a fundamental restatement of the fiscal rules” in the euro zone. And then, he said: “Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term.” This statement has been widely interpreted to mean that Draghi is willing to act as a lender of last resort and buy the bonds of distressed sovereigns, provided a long-term fiscal austerity plan is in place. In short, fiscal tightening must precede monetary loosening. That sounds like a neat compromise between French desperation to have ECB back-up to protect their AAA status and German dreams of a fiscal union with Deutschland uber alles. Since then, German Chancellor Angela Merkel and French President Nicolas Sarkozy have said they want a tough 3% limit on fiscal deficits as a percentage of gross domestic product. They’ve sent out a clear message to the bond markets that the haircuts investors will have to take on Greek bonds are strictly a one-off and the holders of the bonds of other governments will not be meted out similar treatment. IMF funding could also be made available for bank bailouts.
There have been other reassuring developments. Greece and Italy now have technocrats as their heads of government. In Italy’s case, Premier Mario Monti seems determined to give his countrymen the Full Monty when it comes to budget cuts. Despite dire warnings of social unrest, Greece is out of the headlines, at least for now. The coordinated action by central banks in reducing the cost of borrowing by banks in US dollars was a signal that they could act decisively to avert the seizure of financial markets seen after the Lehman collapse. And the ECB is expected to cut its policy rate on Thursday, perhaps by as much as 50 basis points.
The upshot has been a significant fall in bond yields in Europe, a strengthening of the euro and a sharp rise in equities. No doubt, the high cash levels among global fund managers, as pointed out in the Bank of America-Merrill Lynch survey last month, is helping fuel the rally. Fund managers must also be scrambling to reverse the underweight position on stocks they had in November. Also, in spite of spiking bond yields, sovereign downgrades and rumours of a break-up of the euro zone, the euro has hardly been behaving like a currency in its death-throes. Its low of $1.32 in recent months has been higher than January 2011’s low of $1.28. Once again, contrast the huge depreciation of the Indian rupee over the period.
Will the 9 December measures be enough, in Beckett’s words, “to hold the terrible silence at bay”? There is no shortage of warnings that it will, at best, be another attempt to kick Europe’s can of worms a bit further down the road. Doubts have been aired about the ability of Merkel-Sarkozy to push through unpalatable proposals, several countries might need to have referendums to agree, and Merkel has so far studiously avoided any talk of loosening ECB’s purse strings. She has also repeatedly stressed that a solution to the crisis is akin to a marathon, implying no quick fixes. But failure will carry a very high price and the sword of S&P downgrades hangs over all of them.
The bigger question is one of growth. Austerity programmes in the EU will further depress already-low growth. Recent PMI data showed the euro zone private sector contracting for the third month running in November. Willem Buiter, Citigroup chief economist, summed up his expectations about Europe after 9 December in these words: “Lousy prospects, but not a crisis.”
For India, though, Reserve Bank of India deputy governor Subir Gokarn explained in a recent speech that a reduction of uncertainty in Europe could lead to more capital flows into the Indian markets, reversing rupee depreciation and, therefore, lowering inflation. That, in turn, would then lead to monetary easing and higher growth. But we must not forget that we also have our own absurdist drama being played out by politicians to contend with. They could easily offer stiff competition to Beckett.
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com
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