sábado, dezembro 01, 2012

Big Creditor and the the 16 Hong Kongs

Debt Workout 101- part 22 
Trying to explain the  Eurozone credit crunch to Asian investors, it might be useful to use the image of Snow White and the Seven Dwarfs, that is:   the Really Big Creditor Germany and the  sixteen hamstrung economies,  like Hong Kong.  

The Hong Kong dollar is officially linked to the US dollar and the Linked Exchange Rate system operates through a Currency Board mechanism, which requires the Monetary Base to be fully backed by foreign reserves

Hong Kong has no central bank. The smaller members of the Eurozone seem to have a central bank in name only. 

Officially called the euro area, the Eurozone is an economic and monetary union (EMU) of 17 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender:   AustriaBelgiumCyprusEstoniaFinlandFranceGermanyGreeceIrelandItalyLuxembourgMalta, theNetherlandsPortugalSlovakiaSlovenia, and Spain.

Germany is not the only net creditor country running massive  CAB current account surpluses, but it is certainly the biggest, with many times the influence of other surplus countries such as the Netherlands.  

Having joined  the Single Market and the Single Currency, countries can no longer use most of the classic economic adjustment tools since they voluntarily gave up the ability to apply: 

  1. Trade policies such as import restricions and custom duties and tariffs or export incentives
  2. FX Currency devaluation
  3. FX Currency controls 
  4. Controls on cross-border capital flows, equity, debt, or other investments
  5. Interest rate and monetary policy 
  6. Form of determination of market reference rates such as EURIBOR used in long term contracts  
  7. Bank prudential capital requirements, now included  into the Basel-centered regulation 
  8. Benefits and incentives that might be considered drescriminatory or "State Aid"
What economic policy tools are left to the weaker Eurozone member countries to manage such small open economies, exposed to the full force of the tsunamis of hot money and to the competion from much bigger trading partners enjoying economies of scale:  

9. Fiscal and tax policies, from corporate and individual income taxes to VAT valude added tax and stamp duties on lending, withholding tax on interest and/or dividends, etc.

10.  Budget policy, borrow to invest, or even borrow to spend
11.  Credit policy and prudential bank regulation, loan/deposit ratios and other measures left outside of the Basel norms,  auch as local bank supervsion, total leverage, provisioning requirements....
12. Local bank deposit insurance 

Four out of twelve policy tools is not much to keep a fragile economy on the straight and narrow,  especially since these tools are the most difficult to use and the least effective.  And they can be used incorrectly.  For example, the local authorities have not  yet re-introduced the stamp duty on consumer credit, a measure well within their currently limited authority and which could help to curb imports of consumer durables. And they have actually  penalized  local banks for paying higher interest rates on deposits when these banks badly needed to stabilize retail funding and reduce their loan/deposit ratios and to promote local savings. 

Weakened local banks have been doubly penalized by the inter-bank market mechanisms:  they paid ever higher funding costs, until the ECB stepped in, and they earned less and less on their Euribor linked loans, as the Euribor reference group shrunk, from 59 banks originally  to only 34 banks by last count. In practice Euribor is losing its claim to be a true "market reference rate" as it reflects the ever-narrower  top-rated corner of the European banking  market.  

So what is small and  hamstrung economy to do? 

Maybe, in the future, we will take a few pages out of the Hong Kong rulebook, like placing taxes on the inflows of hot money and esasy credit.  For now, the best we can do is to adopt a proactive "credit workout" posture and insist that  the existing external creditors share in the sacrifice and provide true debt relief, in the form of debt restructuring for longer tenors (20 years) and at lower interest rates (2%).   

Given effective local  austerity, a refocusing and reorientation of economic activity to the traded sector, and softer repayment terms, the debtor countries may raise hopes of repaying  their excessive debt, over the very long term.  

Otherwise, the creditor countries can "sit down and wait" for their oan repayments. Unless of course  they can continue to transfer their credit exposure to official multilateral creditors as they have done from 2009-2012.  As the Economist said on 10-Nov-2012, "for two years those rescuers had pretended Greece was solvent, and provided official loans to pay off bondholders in full".   This official pretense  was very helpful to the original creditors who got their bad loans back in full, even as it promoted capital flight and huge TARGET2 imbalances. 

Reducing the external debt burden AND effective external adjustment both require action and effective sharing of the sacrifice  BY the creditor countries, not just FOR the creditor countries as has been done up to now.  
As Wolgang Munchäu said in the FT of 5-March-2012, "The point is that in a monetary union (external account) imbalances do not adjust automatically.  If you want them to adjust, you have to do it yourself."   It shouldn't  come as a surprise, but it did.  And, as always,  in external debt renegotiations, the key issue is relative bargaining power and burden sharing. 

But good economic policies do not easily make good politics.  It takes courageous leadership, to tell voters in both the creditor and the debtor countries what they don´t want to hear AND to run the risk they will vote the messengers out of office.  

But that's the difference between mere politicians and great statesmen, and that's why history overlooks Hoover and celebrates Roosevelt.  

Mariana Abrantes de Sousa

PPP Lusofonia 
See also Eurozone credit exposure by nationality of the Bank