This week in Europe begins with yet another Merkozy meeting
German Chancellor Angela Merkel hosts French President Nicolas Sarkozy Monday, kicking off a week of high-level talks to lay the groundwork for a crunch EU summit on taming the eurozone crisis.
The duo is at the heart of European efforts to stem the debt-driven turmoil threatening the single currency will gather in Berlin for their first monthly tete-a-tete in what is certain to be a rocky year.
There have been so many of these things that it is hard to know what to expect, but the main topic of conversation is likely to be around the implementation of the “Tobin Tax”. Probably not on the agenda, but far more important in my opinion, will be questions from Angela Merkel about what happens in the case that Sarkozy doesn’t win the next election.
French President Nicolas Sarkozy is trailing socialist Francois Hollande in his bid for re-election, a danger for the euro zone that markets appear to have overlooked.
Hollande “will be more hesitant to toe the hard line and may even have a hard time passing a constitutional budget amendment,” says Sassan Ghahramani, president and chief executive of SGH Macro Advisors, a think tank based in New York.
Hollande has pledged to renegotiate Europe’s “new agreement on fiscal discipline” and has called for the European Central Bank to play a larger role, including issuing a common euro bond.
Both ideas are strongly opposed by both Chancellor Angela Merkel and the German parliament.
With France drifting apart from Germany in economic performance as the Euro-Zone slows and France implements an austerity program, Sarkozy is likely to come under increasing pressure at home. It will certainly be interesting to see how the Franco-German relationship holds up as French elections come nearer, and even more interesting if it becomes apparent that Sarkozy is not going to win the election.
One of the big stories from last week was Hungary. Although this may seem like a relatively unimportant country in economic terms, just as Greece did, the major issue with Hungary for the rest of the world is Austria’s exposure.
Austrian banks have an estimated $226 billion in exposure to formerly Soviet eastern Europe and total asset holdings there of €1.14 trillion ($1.6 trillion) at the end of June. Note that the size of the Austrian economy was $332.9 billion in 2010.
This is the reason Austrian bond yields and CDS have been steadily climbing over the last week, even though Austria itself has been relatively stable. I have discussed some of Hungary’s problems previously , but in recent weeks the issues have come to a head with the EU/IMF refusing to provide the country additional help because of a disagreement about new legislation that would undermine the country’s central bank independence.
On Friday Fitch ratings applied additional pressure to the country’s government by joining the other rating agencies in “junking” the country.
Fitch ratings agency piled further pressure on Hungary’s embattled Prime Minister Viktor Orban on Friday as it joined Moody’s and Standard & Poor’s in downgrading the EU member’s debt to “junk” status.
But Orban, against whom tens of thousands of people demonstrated on Monday, defiantly refused to alter new central bank legislation that is holding up agreement on help from the International Monetary Fund and European Union.
Fitch said that the cut by one notch in its rating to BB+ — with a negative outlook — was due to “further deterioration in the country’s fiscal and external financing environment and growth outlook.”
After a few weeks of jaw-boning it now seems that Hungary’s leader is ready to talk.
Hungary is ready to start unconditional talks with the International Monetary Fund, Prime Minister Viktor Orban said Sunday in comments to the MTI news agency.
“For our part, there are no preconditions for starting talks with the IMF,” the conservative leader said in an interview with MTI.
“Any questions that the sides judge important can be put on the agenda,” he added.
Hungary is in desperate need of international credit, and Orban was speaking after a week in which he has seen market pressure on his country ramp up against a background of friction not just with the IMF but the European Union.
Although this maybe good news for Austria in the short-term, none of this will help Hungary’s indebted citizens who are watching their debt burden grow by the day as the forint weakens against the franc.
Like most Hungarians, Toth has a big mortgage, which he was encouraged by his Austrian-owned bank to take out in Swiss francs in 2008, because interest rates in foreign currencies were much lower than in forints. There were 150 forints to the franc then; now, there are 250. As an electrician, he already works 14 hour days, six days a week, and often Sundays as well. But because of the forint’s weakness, the sum he owes keeps growing, and he can already hardly pay the monthly instalments.
How a country ever let its citizens, and therefore its banking system, expose itself to this sort of currency risk is beyond me. Unless the EU/IMF loan can somehow support the currency expect Hungary, and therefore Austria, to be big news over the next few months.
One of the other issues that faces Hungary, and a number of other eastern European countries, is that the European banking system is attempting to re-capitalise. As I have stated before, the banks have two ways to do this:
- 1. Attempt to raise new capital, as we saw with Unicredit last week, or
- 2. Decrease their asset base by slowing lending and/or selling assets.
Given that we saw decelerating M3 in the later part of 2011 it would appear that most banks are taking the later option.
Over the last month one of the big questions from Europe was how the the ECB’s 3 -year LTRO was going to effect the lending behaviour of the European banks. Basically the LTRO allows European banks to get as much reserve liquidity as they can ( based on their assets ) using a long term repo operations. The idea was that if the banking system was flush with reserves then this would support sovereigns via additional debt purchases, but also support the private sector because banks would be more willing to lend. There is some evidence that this operation has been successful in supporting sovereigns, however I was always dubious on the later.
Banks are not reserve constrained, they are capital constrained, and therefore I didn’t really see how providing additional reserve liquidity via repo operations was going to kick off a new round of lending. In fact, as I have stated previously, austerity based policy in most European countries is likely to make the banking system’s asset quality worse and also lower the availability of new credit-worthy clients. Both of these things are certainly not supportive of new lending. Due to my thoughts on this I was on the look out for information that suggests banks were continuing to curtail lending even with the mass of excess reserves in the system. The story of swiss-based PetroPlus suggests that my doubts were warranted.
Struggling Swiss-based refiner Petroplus Holdings AG said Thursday it is continuing discussions with its banks to restore financing and avoid bankruptcy, even as it disclosed that all the company’s credit lines had been frozen.
Petroplus said discussions would continue in “the coming days,” but reported that lenders had suspended access to all credit lines under its revolving credit facility, according to a statement.
The disclosure indicated a deepening of the financing crisis at the Swiss independent refiner, which has struggled amid terrible market conditions for European refiners. Last week, Petrobus disclosed that a $1 billion credit facility was frozen by its lenders and traders, but analysts said the company still had access to other credit lines of more than $1 billion; Thursday’s news suggests it no longer has this source. A Petroplus spokesman didn’t return phone calls seeking comment.
Now it is possible that PetroPlus is actually a company in real trouble and that this particular information has not be disclosed. But this certainly does not read like a story in which the banking system has changed course.
As I mentioned on Friday the Greek PSI+ appears to becoming to some sort of conclusion. The latest news from FT is that the haircut is likely to be bigger than 50%.
Holders of Greek bonds are set to accept higher losses as the contentious negotiations over writing down Athens’ debt burden come to a head in the next week.
People involved with the discussions about so-called private sector involvement, or PSI, said that bondholders were likely to suffer a haircut of 55-60 per cent, more than the 50 per cent originally agreed in October.
Given that banks are big holders of Greek debt this news certainly is going to help spur new lending either. I will continue to watch this area with interest.
Other things to watch this week are the ECB’s policy meeting on Thursday. Market expectation is for a hold a 1% after two 25bps drops. We have quite a lot of action in the bond markets with Greece on Monday and Germany on Tuesday, Spain on Thursday and Italy on Friday. A fair chunk of this is outside the LTRO timespan so expect the ECB to be active.