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The Economist Corner – essential readings VII

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Charlemagne’s notebook

The euro crisis 

 Europe’s 750 billion euro bazooka.  May 10th 2010, 12:26 by Charlemagne

AT two in the morning on May 10th, European Union finance ministers agreed a huge increase in their political will to defend Europe’s single currency, backed by a stunning €750 billion in aid for weak links in the 16 member eurozone. Simultaneously, the European Central Bank took a revolutionary shift away from its inflation-fighting mission, announcing a scheme to buy up government bonds on the financial markets.

That new sense of resolve is good news. The more troubling news is that it took 11 hours of bitter wrangling to get the ministers to that point, and—thanks to continued German anxiety about undermining eurozone discipline by bailing out the profligate—there will be three separate mechanisms to deliver that €750 billion, of such fiendish complexity that EU officials are still not quite sure how it will all work. In a nice irony, the ministers—who have spent weeks denouncing financial markets as wicked speculators—only stopped arguing and agreed a plan in the early hours of this morning because they knew markets were about to open in Asia, well-informed sources say.

Does the good news trump the troubling news? Yes: as long as lingering disagreements and uncertainties do not hold up the rescue plan. Europe is building its own financial bazooka to warn off the markets, to borrow Hank Paulson’s image. If it is ready to fire when needed, then complexity probably does not matter for now.

What has been agreed?

First off, a €60 billion rapid reaction stabilisation fund, controlled by the European Commission, and able to send ready money to eurozone countries that are in a financing crunch. The mechanism is modelled on an existing scheme for non-euro economies, the “balance of payments facility”. The money is borrowed by the commission on the markets, using the EU budget as collateral. Because the EU budget cannot legally go into the red, that means that all 27 EU members are on the hook if money from this €60 billion pot is disbursed and not paid back: to simplify, all members would have to pay extra into the budget to top it up. Britain, for instance, would be on the hook for 12% of any losses: Alistair Darling, still the British chancellor of the exchequer, approved this after consulting his Tory counterpart, George Osborne, by telephone.

Secondly, a “special purpose vehicle” (don’t call it a fund or Eurobonds, or the Germans will be very cross), which will be created in the next few days by an intergovernmental agreement among eurozone members, and which will raise up to €440 billion euro on the markets using a blend of loans and loan guarantees from the 16 members of the single currency club. The European Commission wanted formal control of this warchest, using a clause of the Lisbon Treaty, Article 122 that allows the commission to rush emergency aid to countries hit by natural disasters or exceptional crises beyond their control (Article 122 will be used for the €60 billion pot). Read more in The Economist.

British politics

Britain’s accidental revolution

David Cameron’s new coalition government is a gamble. But it could yet prove a surprisingly successful one.  May 13th 2010 – From The Economist print edition

THE youngest prime minister in almost two centuries; the first coalition government in 65 years; the first-ever Conservative-Liberal Democrat government: by accident, British history was made in all sorts of ways this week. This newspaper had hoped that the election on May 6th would return a single party—the Conservatives—with a strong mandate. But after five days of deal-making and denunciation during which it seemed that a multi-party ratatouille based on a losing Labour Party might take power or a minority Tory government be forced to beg its bread at every vote, the best possible outcome given the ropy electoral numbers has emerged: a formal coalition to implement an agreed agenda containing much of the best in each party’s manifesto. We welcome it.

Rolling up shirtsleeves

There are two broad challenges for the new government led by David Cameron, the Tory leader, and Nick Clegg, his Lib Dem deputy. The first is fiscal. Within two weeks a joint legislative programme must be presented to Parliament. Within less than two months a new emergency budget is due.

The broad policy outlines are clear—and pretty good. Supply-side education reform, the strongest policy in the Tory manifesto, is to go ahead, with the desirable addition of the Lib Dem commitment to put quite a lot of extra money into teaching poor children. Moving benefit recipients from welfare to work, a sound Tory (and indeed Labour) policy, will also be pursued. Labour’s beloved ID cards are to be scrapped, thank heavens, as is the third runway for Heathrow airport. Britain’s independent nuclear deterrent is preserved. Policies on immigration and Europe show signs of struggle and fudge, but the Tory annual cap on non-European migrants survives and the Lib Dems’ amnesty for those already in Britain does not. Read more in The Economist.

A special report on banking in emerging markets

They might be giants

Emerging-market banks have raced ahead despite the financial crisis as their Western colleagues have languished. Patrick Foulis (interviewed here) asks how they will use their new-found strength. May 13th 2010 – From The Economist print edition.

ALONG the breezy three-kilometre stretch of Mumbai’s Marine Drive you pass cricket pitches, destitute people, luxury hotels, plump joggers and advertisements for Indian multinational companies, but almost no bank branches or cash machines. That absence, suggests O.P. Bhatt, chairman of State Bank of India, the country’s biggest lender, gives the visitor a hint of the potential for the banking industry. Marine Drive has been underbanked since it was built in the 1930s. But now there is a palpable sense in India, as in most other emerging economies, that banking is thriving—just as it has fallen into disrepute in many Western countries.

The emerging world has a history of volatility and of bad-debt problems—indeed China is grappling with such a problem at the moment. But developing-country banks now have got things right on a number of fronts. Anti-poverty campaigners can admire their efforts to offer banking services to the illiterate. Technology gurus can see new mobile applications and low-cost IT platforms, and industrialists can count on banks that actually want to lend to their firms. Regulation buffs see an industry that is both armour-plated and wrapped in cotton wool after the crises of the late 1990s and early 2000s. In most emerging economies banks are viewed as engines of development rather than as rent-seeking parasites.

But it is by the hard stuff, money, that banks in the developing world now measure up. Not only are they well capitalised and well funded, they are really big—and are enjoying rapid growth. By profits, Tier-1 capital, dividends and market value they now account for a quarter to half of the global banking industry. China’s lenders head the list of banks by market value, and Brazilian and Russian banks are among the world’s top 25. At current growth rates India’s banks will catch up in a decade. The crisis in Western banking, still reverberating in southern Europe, seems to have accelerated the shift in banking muscle from rich countries to the developing world.

This special report will argue that most of that muscle will be needed at home. To support the fast credit growth their populations and politicians demand, and the bad debts it may cause, emerging-market banks will need more capital than they can generate from retained profits. They are the pre-eminent gatherers of savings in the world, a mirror image of Western banks that became huge borrowers. But they will struggle to use those excess deposits abroad without taking dangerous currency risks, so the job of recycling excess savings abroad will remain with central banks and sovereign-wealth funds. The managers of emerging-market banks have plenty to do as it is. Some of them already run organisations that are far bigger than the biggest Western banks. Most also expect to lose corporate customers to local bond markets and to have to build up their consumer- and investment-banking operations to compensate. Many, too, are finding innovative ways to offer banking services to poor people without losing money. Read more in The Economist.

IMF lending

Keeping afloat

The euro-area bail-out could be the biggest yet. May 13th 2010 – From The Economist online.

SOME of the loans the IMF has made during this crisis have been among the largest in its history. Its extension of a precautionary line of credit to Mexico last year was its biggest commitment in absolute terms. But as a multiple of a country’s “quota” in the fund (the maximum amount that a member state is obliged to put into the IMF’s kitty), the fund’s contribution to Greece’s bail-out is the biggest ever. The IMF is now supposed to fork out half of what the European Union makes available as part of a stabilisation fund for the euro area. If that fund were to be activated in its entirety, the IMF’s contribution would come to €250 billion, or 214 billion SDRs (the IMF’s unit of account). That would exceed the combined size of the ten biggest loans it has ever made, which together involved a commitment of SDR 194.2 billion.


Written by Theophyle

May 14, 2010 at 10:59 am

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