Need coordination between ECB, Germany: IHS Global Insight

The state of affairs in the economies of the peripheral European nations has been analysed over and over again. But what about the core economies that make up the euro zone? No matter how strong, counties like Germany, Belgium and Finland are bound to feel the heat of the debt crisis in the area.

According to Jan Randolph, director of sovereign risk at IHS Global Insight, Germany is already feeling the effects of the slowdown. Being a country that runs of its exports, the sorry state of some of the nations its exports to has hurt sentiment in Germany. “The euro zone crisis is affecting Germany, both on the confidence side in terms of investment, which was particularly weak, but also beginning to impact on their exports as well,” he said. However, Randolph goes on to say that German policymakers have realised this effect, and have therefore stepped up their policy response in coordination with the ECB. “We have a very powerful policy combination there in terms of what the ECB is prepared to and what the Germans are prepared to do with the bailout from the ESM,” he said. So if there is improved coordination between Germany and the European Central Bank, Randolph believes this could be the beginning of the end of the crisis. Below is an edited transcript of his interview with Menaka Doshi. Q: Based on the recent data we have seen that come out of the euro zone, do you think that we are seeing and improvement in Germany’s financials and that Germany today is far better-off than we had anticipated or envisaged in the beginning of the year? A: It has always been the case that Germany, the strongest economy, has been very competitive, successfully selling to emerging markets like Asia, Russia and Eastern Europe. But we must not forget that the rest of Europe is very important for exports as well, export being important growth driver in Germany. What is happening in southern Europe in economies like Spain, Italy and Greece is beginning to impact German exports. So it’s true that Germany is the strongest economy, is the only economy in Europe that has an ability to lift others up as well as bring them down because of extensive supply chain investments for rest of Europe. But the euro zone crisis is affecting Germany, both on the confidence side in terms of investment, which was particularly weak, but also beginning to impact on their exports as well. Q: So how much is core Europe or Germany being impacted by the problems of the periphery, and how much better or worse you expected it to get in few quarters from now? A: You take the sub of euro zone, that’s Spain, Portugal, Italy and Greece. These are the countries worst affected, all in varying degrees of recession. We add them all up though, they amount to about 10% of German exports. So that link is fairly weak, it shouldn’t be that significant. But if we look at the rest of Europe, the countries around Germany, then we are looking at something like half of Germany exports. So the indirect impact is a bit more important for Germany. Also, the effect on investor sentiment is particularly important in Germany given the importance of industry. What happens to German industry in terms of their planning investment is particularly important, and they have been holding back recently. There is a spillover of the negative sentiment in the financial markets falling into the corporate world, which is a bit more damaging for Germany. Having said that, Germany has had a remarkable recovery since the original financial crisis in 2008. In fact, it is probably true to say that it’s the only major Western economy to have come out so well from all these crises. So Germany is extremely resilient to crisis abroad and also the euro zone crisis, but not completely insulated. It has a lot of insulations, but it’s not insulated. Going forward, I think Germany will increasingly shift its exports to emerging markets. It has a perfect industrial policy, selling capital goods to industrializing countries in the emerging markets and also high end consumer goods to middle class everywhere. That is an extremely successful industrial exports strategy and that will remain in place. German unemployment is also at a 20 year low, which is an incredible achievement considering they absorbed East Germany with all its unemployment. So basically they have digested those problems of Eastern Germany and have come out with extremely strong. That of course has helped boost domestic demand, which is also very beneficial. So we are likely to see Germany escape recession, but it’s not completely insulated the euro zone crisis. I think that is why the German government is now stepping up its policy response in coordination with the ECB. We have a very powerful policy combination there in terms of what the ECB is prepared to and what the Germans are prepared to do with the bailout from the ESM. If we are seeing improved management tools in coordination, perhaps that is the beginning of the end of the crisis. _PAGEBREAK_ Q: Germany’s stance on bond buying seems to have changed in the last few weeks. How do you assess the change in that policy stance by Germany when it comes to rescuing the periphery? A: I think Angela has said that what Mario Draghi was proposing in terms of the ECB and what the ECB will do is completely inline with her own thinking about managing the crisis. That is really an important step because what it means that the Germans, assuming the federal German constitutional court approves that the legality of the bailout fund, they can use those funds in all sorts of manners to support banking system or primary bond purchasing. It is important to fight the crisis and that alongside and in-parallel with the ECB using its own balance sheet for buying secondary market bonds, which it is allowed to do, and also at the short end of the yield curve treasury bills, six month bills, 12 month bills of Spanish and perhaps Italian bonds. Those two in combination would be a very powerful policy response and it has potential to turn the tide in the crisis. Q: Under what circumstances will Germany continue to be as conservative as it has been in the last two years when it comes to rescue measures? A: It is interesting to use the word conservative. I mean the German government would say they have done lots progressive, radical things in the life of the euro zone crisis; it has put up most of the money in terms of the ESM bailout fund and a lot of indirect cost in terms of what is happening in the ECB and the various accounts for central banks. The Bundus Bank has got huge credits claims against the rest of the ECB and other central banks in southern Europe. So Germany has got most to lose, and it knows that, which is why it’s prepared to stump up more money. But what Germany doesn’t want to do is provide open ended guarantees or open ended liabilities. If it is going to extend money to Spanish banks, it wants proper oversight. The ECB will be there now to provide the oversight. It’s like having a big family with Germany being the biggest earner. It is prepared to give out credit cards to other members of the family, but we do not give out credit cards unless they have credit limits and guarantees in terms of rules of behaviour in terms of how use those credit cards. So it’s a similar sort of situation to Germany – they are prepared to use their balance sheet, they are prepared to use their economy, but they want proper rules and proper oversight and everyone has to abide by those roles – and that’s essentially is what happening. Q: How do you see the rest of the core Europe reacting to the periphery’s problems, conceding in some of the solutions and backing Germany if it is indeed softening its stance? A: I think Germany is willing to extend financial support and help, but there has to be proper oversight. But this is conditional on performance. In other words, if we take the example of Greece, Germany is open to the idea of allowing another two years to meet structural reform and fiscal targets, as the new government has requested. Now Germany is open to that, but only if the new government in Greece actually starts performing. It is just like an IMF programme. The IMF will support you, with financing, as long as you perform, you pursue policy in the right direction. As long as you are performing, you will be supported. I think it is exactly the same stance the German government has with regards to its money that provided through the Troika in case of Greece or through the ESM for the Spanish. If you demonstrate the political will and you are pursuing policy in the right direction, you will be financially supported. Q: You don’t think that Greece has the political will or the ability to do so, because in your report you expect Greece to exit the euro zone in the coming quarters, I believe by mid 2013? A: To be absolutely honest, this was a big debate we have had with our own company. I am sure it happens in banks and in other companies as well during research and forecasting and ratings. It really is a 50:50 situation whether Greece stays in or out. There is still a possibility of the Greek government even if it is willing to implement cannot implement, and that is the bottomline risk. At the end of the day, only Athens can implement; Berlin cannot implement on their behalf and nor can Bruseels and nor the IMF. Only Athens can implement. Even if there is a willingness to implement, they maybe unable to. In other words, they may face resistance, both inside Parliament and also outside Parliament. If that is the case, then no one is to lend into that situation. No commercial creditor wants to lend into that situation, and no official creditor, German government or IMF, will want to lend to the situation where the political will is fragile or where there is a failure to implement. In other words, you have basically an emasculating government that cannot implement because they face so much resistance either inside or outside Parliament. That is a possibility.