17 May 2012

Vice President Rehn: Overcoming Europe's sovereign debt crisis – the road to stability and growth

The EU's comprehensive strategy has contained the crisis - but not yet tamed the crisis. We need to complete our crisis response; that is, stay the course on fiscal consolidation and reinforce growth through structural reforms and enhanced investment. Thus, our strategy is based on three building blocks.

First, sound public finances are – and will remain – the cornerstone of our strategy. They are a prerequisite for sustainable growth. Relaxing consolidation could at best provide short-lived relief, but very soon endanger fiscal sustainability in many Member States – especially in the medium and long term. At the same time, an adequate rate of economic growth is central to successful and sustainable fiscal consolidation.

Some politicians and pundits are promoting the misperception that the EU fiscal framework forces all Member States into a 'one-size-fits-all' consolidation straightjacket. The Pact entails considerable scope for judgement, based on sound economic analysis, which is an integral part of the Pact's legal provisions. The Pact underlines the structural sustainability of public finances over the medium term, and implies differentiation among the Member States according to their fiscal space and macro-economic conditions.

This is clearly reflected in the "fiscal exit strategy" agreed by EU Economic and Finance Ministers three months ago. They agreed that those Member States with greater fiscal space should let the automatic stabilisers function fully. Meanwhile, vulnerable Member States under close market scrutiny need to convince both market forces and policy-makers of their capacity to tackle their fiscal and other economic challenges and, once again, create confidence.

Second, we need growth-enhancing economic reforms to ensure lasting correction of fiscal imbalances and enhance the credibility of our strategy. Indeed, macro-economic imbalances have reduced significantly. The largest corrections have been recorded in deficit countries, but surplus countries are also adjusting. For example, wage growth in Germany is forecast to be almost 2 per cent in 2012 to 2013, compared to around 1 per cent in the euro area and -1 per cent in Spain. Recent wage negotiations in Germany point further to this direction.

Some deficit countries still need to achieve surpluses to bring their external debt onto a declining trajectory. This requires inter alia further improvements in both price and non-price competitiveness. It also goes hand-in-hand with the need for private sector deleveraging and consolidation of public finances. This is also the key rationale of EU-IMF programmes, which are much more about economic reform to return to growth than only fiscal adjustment. In other words, they are essentially about internal devaluation.

The programmes of Ireland and Portugal are on track. Ireland returned to growth last year, and for Portugal this is expected next year. Outside the eurozone, Latvia has gone through an internal devaluation with the help of an EU-IMF programme, while Estonia and Lithuania have done so without a programme. All three Baltic states are forecast to grow next year with rates of about 3½ - 4 per cent.

As we all know, in Greece adjustment has been slower and return to growth is delayed. Why? Mainly because of the obstacles to reform and growth created by vested interests, lack of national unity, and weak administrative capacity. The reform programme is geared to overcome these obstacles and enable Greece to stay in the euro, which we want. The forthcoming elections are about the commitment to the reforms and the euro. It is a democratic choice of the Greek people.

All in all, we need to maintain the momentum of the wave of reforms that is currently moving in Europe, especially in the countries that need them most. Italy and Spain are taking decisive action in this regard.

We have many encouraging examples. They show that restoring confidence in public finances and undergoing ambitious structural reforms does work. Countries that have best weathered the storm are those that have gone through this kind of adjustment in the recent past. Just look at Denmark and the Netherlands in the 1980s, Finland and Sweden in the 1990s, and Germany in the first decade of this century.

The third part of the building block is the very strong case for more investment. The single market is our main engine for growth, but we need extra fuel to boost that engine. The main problem we are facing at the current juncture is the fragile banking system that cannot provide the funds needed for the structural change. Investors' risk aversion has resulted in fewer and fewer new projects. And financing opportunities are limited because the private banking sector is still reeling from the harsh impact of the crisis.

This is why we have to be innovative. Last year, the Commission proposed the creation of project bonds for infrastructure investment, as a new tool to unlock private funding. Project bonds are not entirely unfamiliar to the UK. Before the financial crisis, monoline insurance companies took over risk from long-term projects.

Given the social returns to infrastructure, our key idea is that we can  and must use public banks better. For the EU, this is the European Investment Bank, or EIB. The EIB and the EU budget can be used more effectively to achieve major leverage through limited risk-sharing with private investors. We are just about to put the legal provisions in place, so that we can launch the first project as early as this summer.

Moreover, the Commission has been urging the EU Member States, who are actually the EIB shareholders, to agree to a capital increase. The EIB could then expand its lending volume, which is a quick and effective way of channelling badly needed financing to the real economy. In addition, the EU Budget would give capital relief to the EIB, so more risky projects could be funded with the participation of private capital.

Full speech

© European Commission