• Sat
  • Jul 12, 2014
  • Updated: 11:24pm

Euro-zone deal a turning point

PUBLISHED : Tuesday, 03 July, 2012, 12:00am
UPDATED : Tuesday, 03 July, 2012, 12:00am

So important is Europe's debt crisis to global economic prospects that financial markets tend to react to any morsel of positive news about efforts to contain it. Usually, after investors have digested the news, an initial rebound peters out because they are hungry for more evidence that European leaders are coming to grips with the issue. The latest news, however, could come to be seen as a turning point. Markets soared after euro-zone leaders agreed to a surprise deal to help Spain and Italy, which have been forced to pay unaffordable interest rates to add to their huge government debt piles. European rescue funds are to be allowed to recapitalise Spain's crippled banks directly, instead of lending to the government, and perhaps also to buy Italian government bonds. Yields on both countries' bonds quickly fell.

The leaders also agreed to scrap the requirement that governments get preferential status over private investors in the event of a default.

These measures buy more time for policymakers to stabilise the situation. They represent concessions by German chancellor Dr Angela Merkel, who had opposed direct cash injections to achieve a longer-term goal. That was to lock Spain, Italy and France into support for important political decisions after 30 months of crisis in the single currency. Initially the most important will be the introduction of a new system of euro-zone banking supervision through the European Central Bank, a first step towards a full banking union.

The leaders also agreed to open talks on closer fiscal and economic co-operation. These reforms are key to avoiding repetition of crises like the present one. Meanwhile, they have agreed on a Euro120 billion economic growth package to soften the impact of austerity measures.

Worryingly, however, divisions remain. Just working out the details and implementation of a banking union - a prerequisite to wider co-operation - will be protracted. It is important to market confidence and global growth that euro-zone governments are seen to approach reform united in a sense of urgency and resolve. Europe is, after all, the biggest export market for China, the main driver of world economic growth, and key to a stronger recovery in the US, the world's biggest economy. As leaders of Europe, Germany and France must show leadership in overcoming political obstacles.

Merkel faced tough questions from German lawmakers about relaxing her opposition to direct cash injections and giving aid without tough conditions. They also fear that without effective guarantees, proposed reforms, including commonly issued euro-zone bonds which would be backed by all the members, would leave Germany to continue underwriting Europe without any greater say to protect its taxpayers. The future of the euro zone therefore depends on closer economic and political union.

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