Faced with a Covid-induced economic disaster last year, EU member states fired every fiscal weapon they had.
That entailed the decision in March to shelve temporarily the bloc’s fiscal rules as member states embarked on massive national-level fiscal expansions, reinforced by a later agreement on a €1.8tn EU-wide budget.
The question facing EU finance ministries in 2021 is what comes next. There has been some good economic news in recent weeks, notably the removal of the risk of a no-deal Brexit. This is coupled with the prospect for a significant fiscal stimulus in the US, as Democrats take control of the presidency and both the Senate and House of Representatives.
Europe’s vaccination drive has been marred by sluggish rollouts but if member states quicken implementation, it should help stimulate economic recoveries later in the year.
Yet none of this changes the brutal truth that the financial fallout from the crisis will be lasting and painful. It will leave a fiscal legacy that pushes public debt loads to 100 per cent of GDP in the euro area as a whole, and to 160 per cent in Italy.
Portugal’s six-month EU presidency will have to tip-toe into this fiscal minefield after taking over from Germany this month. There are two major questions on the table.
First, should the escape clause from EU fiscal rules be extended? As Portugal’s finance minister João Leão said on Friday, support must not be withdrawn prematurely given the fragility of EU economies. A decision on whether to keep the escape clause suspended into 2022 will be made in the second quarter.
Second — and no less consequentially — the EU will need to ask whether it is time to push for deeper reforms to its fiscal rules. Finance ministers and the European Commission shelved this discussion last year as they focused on the immediate crisis. But Brussels will restart a review of its Stability and Growth Pact (SGP) in the coming months.
It faces a range of options from tinkering to more fundamental reforms. The direction of the debate within the economics profession is clear, however: it is time for the EU to take a very long, hard look at a framework that looks hopelessly outmoded given the current economic conditions.
As Laurence Boone, chief economist of the OECD, told the Financial Times this month, the reality of low interest rates and inflation means the scope for monetary policy to play the primary role in stabilising economies has been reduced. Given the European Central Bank has been the cornerstone of financial market and economic stabilisation policy since the financial crisis that started in 2007, the political and institutional implications of such a shift are profound.
If, as Ms Boone argues, it now falls to governments to step forward instead, this would entail some potentially serious changes to the unpopular and labyrinthine SGP.
Ángel Ubide wrote recently for Peterson Institute think-tank in Washington that “sound fiscal policy” can no longer be equivalent simply to deficit reduction. In particular, the SGP’s core targets of 3 per cent deficits and 60 per cent debt-to-GDP ratios look entirely unrealistic, he said. “The focus on debt and deficit levels, rather than on the uses of fiscal policy, is counterproductive.”
The commission’s advisory European Fiscal Board argued last year that the sensible choice is to push through any reforms before reapplying the SGP, rather than waiting until afterwards. It suggested a series of changes including giving countries with higher debt burdens more time to bring down their borrowing, and providing extra leeway for growth-enhancing spending including investment.
Discussions of any changes going beyond tweaks to commission guidelines would take the EU on to treacherous terrain, however, reigniting bitter battles between fiscally conservative states in the north and more expansionary ones in the south.
Alongside those questions lies a much longer term one that has been raised by the ECB, as well as economists including Mr Ubide: whether the EU’s temporary €750bn recovery fund, which is expected to start paying out this summer, should eventually be turned into a permanent central fiscal facility.
These debates will prove politically fraught for the EU. They are also unavoidable.
Chart du jour: the global race to vaccinate
Concerns over the slow rollout of coronavirus vaccination in many EU countries erupted into a blame game last week. Denmark is the best-performing state in the bloc but others are lagging. On Friday, the European Commission announced a provisional agreement to double supplies of the BioNTech/Pfizer Covid-19 jab to up to 600m doses — but most of the extra doses will not arrive until the third and fourth quarters of this year. (chart via FT)
Europe news round-up
Strong German economic data suggest the eurozone’s largest economy avoided a double-dip downturn in the final three months of 2020, despite the latest restrictions to control a fresh surge in coronavirus infections. (FT)
Scottish seafood industry groups have demanded urgent assistance from the UK government after complaining of serious disruption to EU shipments over the past week that raised fears about the survival of some exporters. (FT)
Nationalist prisoner-turned-prime minister Sadyr Japarov has won a landslide victory in Kyrgyzstan’s presidential election, with early results on Sunday suggesting he secured almost 80 per cent of the vote. (FT)
Coming up this week
The European parliament gets its ratification work for the Brexit trade deal under way, starting with a debate in the assembly’s international trade committee on Monday. The EU commission will also hold a series of hearings with MEPs and seminars with national diplomats covering different aspects of the accord. National Brexit attachés will be debriefed on Monday on the agreement’s governance system and on UK participation in EU programmes, while the EU parliament’s fisheries and transport committees will have presentations on relevant parts of the agreement.
The 13th European Space Conference will be held on Tuesday and Wednesday. Later in the week EU commissioners are due to meet for a seminar on the upcoming agenda and Germany’s Christian Democratic Union is due to elect a new leader.
Bets on coronavirus recovery may come good
Markets appear to have got the pandemic right. A plummet in shares as economies locked down gave way to a robust rally: investors trusted in a mix of vaccines, corporate adaptation and central bank stimulus. Mass vaccination programmes in the US and Europe are under way and in countries where they are most advanced like Israel and the UK, economies have unlocked and customers have come flooding back to shops and restaurants.
The virus takes advantage of our social natures to spread but markets had a different, equally human, trait in mind: ingenuity. That includes tech companies whose shares have been among the big winners as they kept businesses operating during lockdowns and new business models allowed shoppers to keep spending. Others too, have adapted, and lockdowns have become less damaging.
Even more important has been pharmaceutical innovation. Researching and developing vaccines has, likely, had among the greatest returns on investment of any human activity — as production accelerates the need to lock down, with its attendant economic costs, retreats. The next challenge — political rather than scientific — is to ensure a sufficient share make their way to poor countries.
With little experience of pandemics, policymakers looked to the financial crisis. Fresh memories of what was in many countries a “lost decade” of meagre improvements in living standards, spurred central banks and governments to open the floodgates. The unprecedented monetary and fiscal stimulus has been notable for its speed as well as its size compared to the response in 2008, reducing long term damage: America’s vast spending, in particular, has added fuel to the rally and stimulus cheques have allowed retail investors to participate.
Claiming victory would be a mistake. The pandemic has been a story of reversals and countries that once looked to have the virus under control finding themselves overwhelmed. That includes, for example, Germany — lauded for its early response but struggling with a third wave — or eastern Europe, initially less affected than elsewhere but now among the most badly hit regions. Other countries which have reopened in the past had to swiftly lock down again as new waves spread.
In 2009, the main US index rose 66 per cent in the 12 months after the trough but it took far longer, and successive crises in the eurozone, before economies would fully recover. Investors who got into the rally early were unlikely to regret it: cheap money helped power a decade-long bull market. This time the rebound has been similar as investors have learnt there is little to be gained from standing in the way of quantitative easing.
The big question remains the outlook for inflation. With little sign of economies returning to capacity after the financial crisis central banks kept rates low and asset purchases high, flooding the financial system with liquidity. A stronger recovery from the pandemic, thanks to a mix of government stimulus and households spending accumulated savings could see prices and wages start to creep up again — central banks may start to withdraw support too. The pandemic has also disrupted supply chains raising price pressures further.
Record first-quarter growth in China, where the recovery is more advanced, has already shifted the focus to “overheating” and the prospect of rate rises. An end to the persistent “lowflation” of the decade after the financial crisis would be a far better outcome for the whole world but it might mean markets have got ahead of themselves.
Biden imposes tough new sanctions on Moscow
US president Joe Biden has imposed sweeping new sanctions against Russia including long-feared measures targeting its government debt in a sharp escalation of Washington’s confrontation with Moscow.
The first anti-Russian measures from the Biden administration also include the expulsion of 10 Russian diplomats from the US and sanctions against 38 entities, individuals and companies accused of taking part in efforts to interfere in US elections and conduct cyber attacks.
On Wednesday, the US for the first time formally blamed SVR, Russia’s foreign intelligence service, for the SolarWinds hack, which affected at least nine federal agencies and 100 companies. One senior administration official told reporters the hack gave Russia “the ability to spy on or potentially disrupt more than 16,000 computer systems worldwide”.
News of the measures sparked a sell-off in Russian assets and a warning from the Kremlin that they would harm efforts to reduce tensions between the two countries.
The fresh sanctions ban US financial institutions from trading in newly issued Russian state debt, known as OFZs, and bonds issued by the Russian central bank and National Wealth Fund. The ban affects debt issued after June 14.
Measures targeting new state debt have long been viewed as a “nuclear option” for the US and a milestone in Washington’s sanctions regime against Russia, which has steadily expanded since the first round of restrictions were imposed by the Obama administration in response to Moscow’s 2014 annexation of Crimea.
In remarks at the White House on Thursday afternoon, Biden played down the severity of the actions, saying the US wanted a stable, predictable relationship and was “not looking to kick off a cycle of escalation and conflict with Russia”.
“I was clear with President (Vladimir) Putin that we could have gone further, but I chose not to do so,” Biden said, referring to recent telephone conversations between the leaders. The US president said he was still prepared to take further action to respond to Russian aggression “in kind”.
The senior administration official said the new sanctions package would “impose costs for Russian government actions that seek to harm us”. The official added some US responses would “remain unseen”. The moves come after strong condemnation from Washington and other Nato powers over Russia’s heavy military build-up close to its border with Ukraine.
The package includes sanctions on 32 individuals and organisations accused of interfering in recent US elections, and six Russian technology companies alleged to support the country’s intelligence services, in view of the SolarWinds hack.
The rouble dropped as much as 2.2 per cent in early trading on Thursday to about 77.5 to the US dollar. It trimmed some of its initial losses and was down 0.7 per cent to trade at 76.41 by 2pm London time.
The decline in the value of the Russian currency erased gains made earlier in the week after a Tuesday call between Biden and Putin, in which the leaders discussed a potential joint summit aimed at easing tensions.
Moscow’s benchmark Moex stock index was down 0.6 per cent, while the market’s dollar-denominated RTS index was 1.8 per cent lower.
The country’s benchmark 10-year bond yield rose 0.19 of a percentage point to 7.24 per cent, a touch below recent highs. Bond yields rise as prices decline.
The EU and Nato both issued statements expressing “solidarity” with the US over the sanctions.
Dominic Raab, British foreign secretary, said the US and UK were aware of Russia’s actions to undermine their democracies. “[We] are calling out Russia’s malicious behaviour, to enable our international partners and businesses at home to better defend and prepare themselves against this kind of action,” he said. “The UK will continue to work with allies to call out Russia’s malign behaviour where we see it.”
The UK’s security review, published last month, identified Russia as the “most acute threat” to its national and collective security, citing “hostile and destabilising” activity by Moscow.
Russia’s foreign ministry responded to news of the sanctions by summoning the US ambassador to Moscow for what it said would be a “difficult” discussion.
“Such aggressive behaviour will certainly be strongly rebuffed, and the response to sanctions will be inevitable,” ministry spokeswoman Maria Zakharova told reporters. “Washington must realise that it will pay for the degradation of bilateral relations.”
The Kremlin said earlier on Thursday that fresh sanctions could scupper efforts to arrange the planned summit between the two leaders.
However, in his remarks on Thursday, Biden said he thought the summit would still take place in Europe this summer, adding teams from both countries were discussing the event.
The Biden administration began drawing up measures to punish Russia following the SolarWinds hack, which officials said at the time was “likely of Russian origin”.
Russia has denied involvement and said it had never attempted to influence foreign elections.
The US has also condemned the recent arrest and jailing of Russian opposition activist Alexei Navalny after his recovery from a suspected assassination attempt, and accused Moscow of threatening Ukraine by deploying tens of thousands of troops to the country’s border.
A senior administration official said the US was not taking any countermeasures in view of a US intelligence assessment that concluded with only “low to moderate confidence” that Russian intelligence officers paid the Taliban to attack US and allied personnel in Afghanistan in 2019 and perhaps earlier. The official said the US would instead issue “strong direct messages” to Moscow.
The share of Russia’s rouble-denominated Treasury bonds held by foreigners fell to a more than five-year low of 20.2 per cent in March, down from more than 30 per cent a year earlier.
The sanctions will test the Russian finance ministry’s plans to soften the impact of restrictions against its sovereign debt. Potential countermeasures include a pause in issuance and regulatory easing for Russian borrowers, deputy finance minister Vladimir Kolychev told the FT late last year.
The ministry is also confident that, if needed, it can replace foreign OFZ holders entirely through domestic demand.
After cancelling a bond sale in March due to market volatility and sanctions fears, Russia sold a record Rbs354bn ($4.6bn) in OFZs a week later, with most of the issue going to Kremlin-run banks.
Additional reporting by Max Seddon in Moscow, Lauren Fedor in Washington and Hannah Murphy in San Francisco
Biden will not change Putin but is right to talk to him
The west’s approach to Vladimir Putin’s Russia regularly falls prisoner to the perennial debate about realism and idealism in foreign policy. The choice is posed as between engagement and confrontation, the pursuit of interests and defence of values.
As Putin apparently threatens war in Europe by overseeing a menacing build-up of Russian troops on Ukraine’s eastern border, two thoughts arise. The Russian president is not about to change his ways. And the US and Europe have to deal with him.
Putin has been a big loser from Joe Biden’s presidential victory. Donald Trump fell under his spell. When they met in Helsinki in 2018, the then US president said of the evidence of Russian meddling in the 2016 US election, that he preferred the word of a former KGB operative turned Kremlin autocrat above that of his own intelligence agencies.
Trump offered Putin the respect he craves. It is always a mistake to underestimate the role of vanity in politics. Putin never forgave Barack Obama for an off-the-cuff reference to Russia as a “regional” power. Above all, Putin wants to be treated — and seen by Russians to be treated — as the leader of a nation that still stands as an equal with the US. The lopsided alliance he has forged with China will never serve as a substitute.
Biden’s victory has derailed eternal Kremlin hopes of splitting the Atlantic alliance. Washington’s relations with its European partners are warmer than for many years. German chancellor Angela Merkel looks increasingly friendless in her stubborn backing for the Nord Stream 2 pipeline being built to carry Russian gas under the Baltic Sea. French president Emmanuel Macron has failed in his efforts to recalibrate the relationship with Moscow.
Western diplomats are not sure what to make of the latest troop build-up. It contains an obvious warning to Kyiv not to seek to overturn the ceasefire with the pro-Russian separatists who seized territory in Ukraine’s Donbas after Moscow annexed Crimea in 2014. And there is a message to the US and Nato not to write a blank cheque for Volodymyr Zelensky, Ukraine’s president, and his government.
Whatever the Kremlin’s ultimate military intentions, the deployments have served Putin’s purpose in grabbing the attention of the White House. Until this week Biden had largely ignored him, while offering a blunt assessment of the Russian regime. Putin is a “killer”, he remarked last month. Moscow was put on notice that the US would respond vigorously to cyber attacks and meddling in US elections.
The US president’s offer this week of a summit on neutral territory to discuss Ukraine and a clutch of other issues looks calculated to appeal to Putin’s vanity. Success or failure, a summit will offer clarity. And if it can take some of the tension out of the relationship by massaging Putin’s ego, why not.
It will not presage, however, a fundamental change in the relationship. The “reset” story has been played out many times during the past decade or so. The offer of a fresh start has come from several western leaders.
Logically, Putin should be attracted to the idea. Russia can survive US and European sanctions, but it badly needs western investment and technology. Its long-term strategic interests lie in a close economic relationship with Europe. If the Kremlin is in search of threats, it would do better to take a close look at China’s Eurasian ambitions.
Russia’s interests, though, are not Putin’s. His priority is the preservation of his own power and wealth. Autocrats need enemies. The supposed threat from the US and its allies sustains his populist pitch to Russian nationalism.
The question then becomes how much room there is for co-operation — whether on nuclear arms control, backing efforts to restore the nuclear agreement with Iran, or promoting stability in Afghanistan when US troops complete their withdrawal this year. The answer must be that the possibilities are worth exploring. Putin has already accepted Biden’s offer to extend the last remaining strategic arms treaty.
The notion of a binary choice between realism and idealism has never held much credibility. The argument that usefully can be had is not about the fact of engagement, but about its nature. Where does the line fall between securing interests and compromising values?
The idealists have a point when they say that the some of the overtures to Moscow in recent years have looked more like capitulation than engagement. Biden seems to have got the balance about right. Where it can, the west should work with Russia. Just not on Putin’s terms.
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