Tricky keeping EU show on road, even with roadmap: Expert

In an interview to CNBC-TV18, Arnab Das of Roubini Global Economics says that this week’s European Union meet is just like all the ones before it. “I don’t think we are going to have a definitive definition about what the road map is going to be, how it’s going to play out or what the end game is going to be,” he said.

However, even if a roadmap is announced, Das says it won’t be enough to help the eurozone stay afloat. “A roadmap is just a way to get from A to B; there is no guarantee that once you are on that roadmap that you are going to stay on track,” he explained. He believes there may be political constraints arising from the individual governments in each country. “It may even work but there is going to be a lot of noise along the way, a lot of uncertainty and some countries are almost certain to fall by the way side,” he said. He further adds that it will be difficult for a fiscal integration to come about because voters in each country will choose to their own self interest instead of the greater good, especially in times of crisis. Below is an edited transcript of his interview with Menaka Doshi. Also watch the accompanying video. Q: We have been through dozens of these EU summits in the last couple of years, and I know every meeting is meant that we are taking steps, but they really are only baby steps right? A: Yes, that’s exactly right. There have been so many of these summits, this is just the latest in the series and it’s almost certainly not going to be the last one. I don’t think we are going to have a definitive definition about what the road map is going to be, how it’s going to play out or what the end game is going to be. I would go even further and suggest that even if they come up with a fairly well defined roadmap, as people are calling it, that might not end up being good enough. A roadmap is just a way to get from A to B; there is no guarantee that once you are on that roadmap that you are going to stay on track. We still have 17 vehicles of state, each of them with an independent sovereign government that have different views about what to do, and what’s been cobbled together here in that working paper is a technocratic view of what should be done given the political constraints to do what's ideal and optimal to make this currency viable and durable. It may even work but there is going to be a lot of noise along the way, a lot of uncertainty and some countries are almost certain to fall by the way side. What’s really concerning is that this is no longer just about Greece. A variety of countries are now in distress, but it is becoming more and more mainstream gradually to talk about euro exits in countries other than Greece. Infact, more so than in Greece. So people are talking about this is Italy; may be just is a way of running against Monti and capitalizing on the political problems he is facing as a technocratic Prime Minister. Nevertheless there is that pressure and there is pressure in the core as well. So even if we have a very good definition, which we doubt that we’ll get out of this eurozone summit, we are still going to have a lot of problems keeping the show on the road once the roadmap is in place. Q: Given those constraints, given the yield situation, given the Spanish bank situation, what is it that you would like to see emerge as an outcome or a set of outcomes at the end of this week’s two day summit? A: I think if they do signal that they are ready to go along with the idea of a banking union, liability union which is this idea of euro bonds or euro bills or some variant of it, , fiscal integration, political integration; if they are willing to go and put all of those things or some critical mass of them on the table, the markets will take heart, the shorts will be squeezed, there will be something of a relief rally. All I am suggesting is that that relief rally might not be sustained for very long once this plan comes up against the buffers of political reality. The underlying truth of this kind of fiscal union is that you have to get the voters in practically every country to vote against their own narrow self interest and in favour of the greater good. That is quite difficult to do at the best of times, let alone in a crisis right. Heroes think about other people in crisis; ordinary people think about themselves. Therefore governments which are elected by ordinary people have to think about their own countries. Q: From what I read, the two key things that might amount to banking integration are a common bank regulator and more importantly a scheme that guarantees bank deposits across the EU. Now a lot of people in the recent past have drawn a parallel between what went on in the US when the Federal Deposit Insurance Corporation (FDIC) came in with that deposit insurance and help step a run on banks. What according to you does banking integration entail? A: To me banking integration is a stalking horse for fiscal and therefore political integration. It worked in United States because the FDIC can call on the premiums that deposit taking banks that are FDIC banks pay into the FDIC. Now those premiums are never enough to quell a kind of a run on that part of the banking system. So when the FDIC runs out of resources, it is actually formally instated to be backed by the full faith and credit of the United States. So the financing for the deposit insurance in United States comes from the federal treasury. So it is still a stalking horse for fiscal integration. It is not just about the deposits; deposits obviously are the most important part and that is kind of the top of the capital structure of the banking system. But that deposit run is taking place because there is a bad asset problem, an NPL problem, that is reflected in the loss of equity in the banks and a run on the wholesale liabilities of the banking system. So ultimately what you need to do is to recapitalize the banks. But if a big part of the bad debt in the banking system is ultimately potentially public debt, as it proved to be the case in Greece and may still prove to be the case in Spain or in Italy, then you have a very serious problem because that country cannot stand behind its banking system. You have to mutualise it and socialise it across the whole eurozone which takes you right back to this question of fiscal and political integration. _PAGEBREAK_ Q: What you are saying is that banking integration is a proxy, a smaller proxy but a proxy nonetheless for fiscal and political integration. You cannot do banking integration unless you have fiscal or closer fiscal integration and by that do you mean a common treasury? A: I think you need to have a common treasury and ultimately what you need to do is share tax revenues. You need to have a system of representation that is European, not national. Bonds are just taxes in the long run, and to have taxes without representation, well that’s how we got a breakaway republic in the US from Great Britain. So that might be another reason for part of the eurozone to breakaway from each other if people feel that their resources and their hard earned money and their hard earned tax payments are being squandered on people in other countries over whom they have no influence or control. So that’s essentially what Germany is saying, which is that we can have euro bonds, maybe we can have liability union or fiscal union, but we are going to put that at the end of the process of political integration so that we have a say over how our sources are used, rather than putting the cart before the horse once again. Q: How realistic is it to expect that any of this will get done? I thought banking integration was the first step towards broader integration, but you are saying that it’s a subset of broader integration which means that forget this week, this month or this year, what you are talking about is 5-10-15 years solution. A: Yes, I think that’s exactly right. We need to have as you said more of these baby steps and we need to lay out a roadmap to a very clear end game. Once we have done that and made a pre-commitment to this roadmap we need all 17 member States to stay on it. Any major deviation, even if we get the roadmap, even if we like the direction and we like the end point, the market take heart from all those things, they need to see more or less sticking to that story because there are plenty of monetary unions in the world, there are fiscal federations, there are political unions that have lots of instability or that have financial repression as a way of keeping the show on the road and keeping everything together. In Latin America you have Argentina and Brazil that are monetary unions that have single federal government that have had periodic blowups in the financial system and in the balance of payments because they haven’t been able to control state level regional excesses that have been passed into the banking system and have become a serious banking problem, passed up the chain to the central bank and up to the Federal government resulting either in hyper inflation or sovereign default or both. In India we have this problem as well. It’s quite hard for the Federal government to control the fiscal continence of the states, or even its own fiscal accounts. The way we deal with in India has been through financial repression - by nationalising the banking system, by putting government bonds into the banking system under a system of capital controls. Often you have below inflation negative real interest rates on deposits and on those government bonds. Now either of those solutions might in some sense work, in that they might keep the eurozone from blowing up and creating a regional and global catastrophe but it wouldn’t work very well. It’s one thing for Argentina or Brazil or even India to have this incomplete and imperfect way of running a fiscal federation. But for the second largest currency union in the world which is at risk of a major problem or at best the kind of muddle through, that part of the international system needs to be very stable, needs to function well, needs to be a contributor to a regional and global financial stability and economic prosperity. Anything less and we are going to continue to have some amount of financial instability which is going to complicate the global recovery which itself is already fragile. Q: Do you expect Spain’s bank bailout will eventually turn into a full-fledged bailout request? A: We certainly do. It maybe not this year, but it will come to pass that Spain will need some sort of a bailout. If they don’t, if they keep trying to fudge it, conditions will be that much worse. Right now we have a Spanish bailout programme for the banks which is flowing through this state budget without a programme. So what’s happened is that they should be making it up as they go along. With the three small countries you had programme with enforcement conditionality and you had a way of tracking it, whether it’s on track or off track. That way you are able to make distinctions and differentiation between Greece which is off-track, Portugal which is still stagnating but is trying and succeeding generally to meet or exceed its performance criteria, and Ireland which had been doing the best of the three countries. So that allows a lot of discrimination. With Spain you won’t know what is going on because all we know is that they do not have an official programme. Various creditor countries are saying why there is a lot of conditionality; we have no way of knowing. All we can do is wait around every quarter and see what happens to the budget numbers, what happens to the growth numbers, what happens to the banking numbers and its all going to look ugly or even uglier than it might other look as a result of that lack of information and clarity.