Economic Crises

It now appears that the Cypriot Parliament will reject the government’s amended plan for haircutting deposits. The revised proposal, which reportedly exempted depositors under €20,ooo, satisfies almost no one–Cypriot depositors, the Russians, nor European creditors (including their increasingly agitated banking regulators).   The government looks ready to try and renegotiate the bailout, but no creditors have stepped up to fill the hole left by the failure of the tax.  There may be pressure on Cyprus for additional fiscal measures, but it’s hard to see that as confidence boosting given the damaging growth effects we have seen in the periphery following aggressive fiscal cutting. The most likely scenario would seem to be to revise the tax to fully exempt insured depositors.  But how to fill the gap while still maintaining a viable debt path?  One approach would be to restructure the sovereign’s €8.2 billion debt.  I have blogged in favor of this in the past. Whether or not it becomes part of the plan, I think the government will have a hard time explaining to its citizens why external bond holders are being paid in full while they are being taxed. One thoughtful approach on how to move forward has been tabled by Lee Buchheit and Mitu Gulati.  Their plan has three elements: 1.  Protect all insured depositors (no tax). 2.  Uninsured deposits in excess of €100,000 would be replaced, at par, with interest-bearing and tradeable bank certificates of deposit. A menu of different rates and maturities could be offered, and the CDs could be partly secured by natural gas revenues.  (I would add here that the CDs could alternatively include an option that would pay out if the government is successful in exploiting its natural gas reserves.) This would mean a loss to depositors in net present value, but provides security and principal conservation. 3.  The maturity dates of all sovereign bonds would be extended by five years, without a haircut to interest or principal. This approach would reflect a rank ordering of creditors that makes sense (and more closely matches the principles of creditor ranking in bankruptcy), as well as a more politically sustainable burden sharing.  It would lock in funding for the banks.  Most importantly, it keeps Cyprus’ main creditors "at the table".  If good policies and a natural gas boom makes Cyprus’ debt and fiscal policy sustainable, creditors would avoid a loss of principal and perhaps even capture some upside; if not, the future restructuring could be calibrated to the need.  Anna Gelpern and Felix Salmon also have analyses of the proposal out. Whatever path is chosen, they need to move quickly.  The bank holiday is unsustainable for long on political and economic grounds, and if not resolved the question of euro exit could move to center stage.

On Saturday, 3,000 demonstrators turned out in Singapore—in one of the biggest protests in the country’s history—to protest the government’s new plan to increase the tiny nation-state’s immigrant population by nearly two million people by 2030. And who are this proposal’s greatest opponents? The Singaporean middle class, which has increasingly seen its political capital and purchasing power strangled by the influx of wealthy immigrants, mainly from China. Migration is just one the pillars of globalization that has been badly damaged as a result of the global financial crisis. In a new piece for The National, I argue that—contrary to the hope of many economists, businesspeople and leaders—the global economy is not bound for a new era of increased integration. Oppositely, I contend that today’s crisis will produce the worst deglobalization in modern history; and I explain how migration, foreign lending, and trade will all suffer as a result. You can read the piece in its entirety here.

  The International Monetary Fund (IMF) has again downgraded its outlook, reducing its forecast for global growth by 0.1 percentage points to 3.5 percent this year and 4.1 percent next year.  For Europe, in particular, there is not much good news: European growth has been marked down 0.3 percentage points to -0.2 percent in 2013, a second year of decline.  The IMF optimistically forecasts a gradual pickup in Europe later this year, but also sees Europe as the key downside risk to the outlook. Advanced economy exports have been marked down 0.8 percentage points to 2.8 percent.  Last year, the improvement in the current account performance of the European periphery came through stronger exports to non-European countries rather than to the European core.  It is hard to see how exports can be their locomotive for growth going forward. The European downgrade reflects “delays in the transmission of lower sovereign spreads and improved bank liquidity to private sector borrowing conditions.”  That’s key: private sector lending is down 0.5 percent over year earlier levels with little sign of a pickup.  In other words, banks are strengthening their balance sheets in part by not lending.  As long as Europe continues to face headwinds from fiscal drag, private sector deleveraging, weak export demand, and bank lending constraints, the outlook for growth and debt sustainability in the periphery will remain grim.

While congressional action lags, a series of year-end fiscal measures could derail the U.S. recovery.

The current debate over how to finance Greece has again put the spotlight on the unsustainable buildup of sovereign debt in the periphery and led to calls for a comprehensive strategy for official sector involvement (OSI).   Until now, creditor countries have resisted OSI, establishing “red lines” that lead them to ad hoc and temporary efforts to reduce debt levels and fill financing gaps. These efforts buy time, but don’t address fundamental concerns about debt sustainability, build market confidence, or maintain public support for painful austerity.  Resolving the European crisis will require concrete measures to deal with the large and growing European sovereign debt overhang, sooner rather than later. Fortunately, we have a model for dealing with a debt overhang that has worked well--the “Paris Club”, the informal group of official creditors that since 1956 has met to deal with payment problems of emerging market debtor countries.  For countries in crisis, the Paris Club provides rescheduling of sovereign debt owed to official creditors for either a defined period (a flow rescheduling) or a set date (a stock approach). While the Club’s operations, geared as they are to low and middle-income countries under International Monetary Fund (IMF) programs, will on the surface seem ill-designed for large, complex industrial economies of Europe, I would argue that the Paris Club has three principles that should be central to the European approach. First, it has a set of rules for the terms of restructuring based on the countries’ income and debt level that is known in advance.  These rules are named for the city where they were agreed–-Houston, Naples, Cologne--though in practice the scale of debt relief will depend on a case-by-case assessment of the financing need of their program. Second, Paris Club restructurings are conditional on a proven record of performance under an IMF program.   In the European context, there is an unfortunate but real stigma associated with IMF programs and conditionality, but nonetheless making relief conditional on performance (in this case under an EU program) is essential to address legitimate moral hazard concerns. The third key principle is seniority for new lending and for trade finance.  The Paris Club sets a “cutoff date” and the restructuring, as well as any future restructuring, will apply only to debt originally contracted before that date.  This means that new lending is, in practice, senior to old debt, which is critical to creating an environment for capital to return to the country. If such a framework were in place in Greece, the IMF would not be in the unenviable position of approving a review that so clearly fails its financing assurance and debt sustainability tests, and the troika would not be deadlocked over OSI. European leaders understandably are concerned about the costs of setting precedents when dealing with the crisis of the moment, as well as associating with a crisis management approach known for low-income emerging markets.  But the costs of inaction are growing too large.  Europe needs a Paris Club for European debt.  Call it a consultative group if needed; hold it in Berlin, Amsterdam or Brussels (though it would be a shame not to take advantage of the French existing expertise and infrastructure).  But the sooner these rules are established, the sooner we can see a return to voluntary capital flows.